Financial MGT Problems

1.

(Expected rate of return and risk) B.J Gautney Enterprises is evaluating a security. One

-

year Treasur

y

bills are currently paying 3.8

percent. Calculate the investment’s expected return and its standard

deviation should Gautney invest in this security?

a.

The

investments

expected return is ……. %

2.

(Computing the

standard deviation for an individual investment

) James Fromholtz

is considering

whether to invest in a newly formed investment fund. The fund’s investment objective is to acquire

home mortgage securities at what it hopes will be bargain prices. The fund sponsor has suggested to

James that the fund’s performance will hi

nge on how the national economy performs in the coming

year. Specifically, he suggested the following outcomes:

a.

Based on these potential outcomes, what is your estimate of the expected rate of return from this

investment opportunity?

b.

Calculate the standard deviation in the anticipated returns found in part

a .

c.

Would you be

interested in making such an investment? Note that you lose all your money in one

year if the economy collapses into the worst state or you double your money if the economy enters

into a rapid expansion

State of Economy

Probability

Fund Returns

Rapid expansion and recovery

5%

100%

Modest growth

50%

30%

Continued recession

40%

10%

Falls into depression

5%

-

100%

a.

The expected rate of return from this investment oppo

rtunity is ……. %

Probability

Return

0.05

-

5%

0.40

1%

0.50

5%

0.05

8%

1. (Expected rate of return and risk) B.J Gautney Enterprises is evaluating a security. One-year Treasury

bills are currently paying 3.8 percent. Calculate the investment’s expected return and its standard

deviation should Gautney invest in this security?

a. The investments expected return is ……. %

2. (Computing the standard deviation for an individual investment) James Fromholtz is considering

whether to invest in a newly formed investment fund. The fund’s investment objective is to acquire

home mortgage securities at what it hopes will be bargain prices. The fund sponsor has suggested to

James that the fund’s performance will hinge on how the national economy performs in the coming

year. Specifically, he suggested the following outcomes:

a. Based on these potential outcomes, what is your estimate of the expected rate of return from this

investment opportunity?

b. Calculate the standard deviation in the anticipated returns found in part a .

c. Would you be interested in making such an investment? Note that you lose all your money in one

year if the economy collapses into the worst state or you double your money if the economy enters

into a rapid expansion

State of Economy Probability Fund Returns

Rapid expansion and recovery 5% 100%

Modest growth 50% 30%

Continued recession 40% 10%

Falls into depression 5% -100%

a. The expected rate of return from this investment opportunity is ……. %

Probability Return

0.05 -5%

0.40 1%

0.50 5%

0.05 8%