James Fromholtz is considering whether to invest in a newly formed investment fu
ID: 2738631 • Letter: J
Question
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 possible outcomes:
a.Based on these potential outcomes, what is your estimate of the expected rate of return from this investment opportunity?
b.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.
Explanation / Answer
a) Calculation of Expected Rate of Return Outcomes Probability Return %age Expected Return If Economy Collapse 0.5 -100 -50 If economy expands 0.5 100 50 Expected Return 0 Note: This is based when there is equal probability of economy collapse and expansion. b) Investing in the said fund depends upon many factors. One of which is risk apetite of investor. A risk lover investor will always wants to invest in this because he may get 100% return over it. However a risk averse investor will keep a gaap from these kinds o investment.
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