Suppose that a security costs $3,000 today and pays off some amount b in one yea

Question

Suppose that a security costs $3,000 today and pays off some amount b in one year. Suppose that b is uncertain according to the following table of probabilities: b: $3,000 $3,300 $3,600 $3,900 $4,200 Probability: 0.1 0.2 0.3 0.2 0.2 a Calculate the return (in percent) for each value of b. (Note: You may just calculate the total return and not worry about how this is split between current yield and capital-gains yield.) b Calculate the expected return (in percent). c Calculate the standard deviation of the return. d Suppose that an investor has a choice between buying this security or purchasing a different security that also costs $3,000 today but pays off $3,300 with certainty in one year. How is an investor

Explanation / Answer

a) the return : { 0, 300, 600, 900, 1200} b) expected return = 0.1*0 + 0.2*300 + 0.3*600 + 0.2*900 + 0.2*1200 = 660 c) standard deviation = root{[(0-600)^2 + (300-600)^2 +0 + (900-600)^2 + (1200-600)^2]/5} = 424.26 d) This security would give him an expected return of 660 with a sd of 424.26, whereas t...

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