Directions: You MUST show ALL of your work to receive credit on the problems. Th

Question

Directions: You MUST show ALL of your work to receive credit on the problems. There will be significant point reductions if you do not show your work. All calculations should be completed to at least 2 decimal places.

1) The common stock of Leaning Tower of Pita Inc., a restaurant chain, will generate payoffs to investors next year, which depend on the state of the economy, as follows:

The company goes out of business if a recession hits. Calculate the expected rate of return and standard deviation of return to Leaning Tower of Pita shareholders. Assume for simplicity that the three possible states of the economy are equally likely. The stock is selling today for $80.

2) Calculate the nominal return, real return, nominal risk premium, and real risk premium for the following common stock investment: (Show your work)

3) How much is an investor's tolerance for risk worth over a long horizon? Calculate the difference in accumulation in real terms for an investor who initially invests $25,000 and ignores it for 20 years in either a long-term Treasury bond portfolio or a portfolio of diversified common stocks. Assume the historic real returns of 2.1% annually for bonds and 9.3% for common stocks.

Explanation / Answer

3)The investor tolerance for risk worth over a long horizon will be less.

Invest in teaury bond=25000*(1+2.1%)^20=$37,883.91
invest in porfolio of stock=25000*(1+9.3%)^20=$148,027.79

The difference in real terms betwenn two is 148,027.79-37,883.91=$110,143.87 and this is approximately 4 times the initial investment

Related Questions

Navigate

• Browse (All)
• Browse D
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.