Exercise 1. Imagine you have $5000 you want to invest. Swift corporation\'s stoc
ID: 2819602 • Letter: E
Question
Exercise 1. Imagine you have $5000 you want to invest. Swift corporation's stock is currently selling for $100. The stock price will either go up to $120 or go down to $90 with equal probability. Consider the following potential strategies a Invest all $5000 in the stock b Borrow $5000 from your broker. Invest all $10000 in the stock. From the proceeds, pay the broker back the $5000 owed (no interest) c Put the $5000 in a risk free T-bill that gets 2 percent d Short sell $5000 of stock. Put all $10000 in T-bills that earns 2 percent. For each of those strategies: » What are all possible payoffs? » What are the possible returns? What is the expected return? What is the variance of the returns?Explanation / Answer
1. Possible payoff's
a. In stock - You can buy 50 shares. So your value can be either 120*50 = 6000 or 90*50 = 4500
b. You value can be 12,000 -5000 = 7000 or 9000-5000 = 4000
c. You can get $5000*1.02 = 5100
d. 10,000 in till bills will give =10,200. Your short sell will result in a loss of 1000 or a gain of 500
Your returns or 4200 or 5,700
2
a. Possible returns with full stock investment = 20% or -10%
b. Possible returns by borrowing from broker = 40% or -20%
c. In T-bills = 2%
d. In short sell = -16% or +14%
3. Expected returns:
a. Stock investment =20%*0.5 -10%*0.5 = 5%
b. Borrow from broker = 40%*0.5-20%*0.5 = 10%
c. T bills = 2%
d. Short sell = -16*0.5+14*0.5 = -1%
4. Variance in returns We have used excel var() function to calculate teh variance
Stocks Brokker T-bill Short sell Possible return 1 20% 40% 2% -16% Possible return 2 -10% -20% 2% 14% Variance 4.50% 18.00% 0.00% 4.50%Related Questions
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