An investment advisor is considering four different investment options for a cli

Question

An investment advisor is considering four different investment options for a client. The return of each option depends on the state of the economy over the next year (ranging from rapid expansion to strong contraction).The investment company's economists have estimated probabilities for each of these states of the economy, as well as the returns of each investment under each of these circumstances. The data is summarized in the spreadsheet below.

Data for Essay Question Midterm 1 Spring 2018.xlsx

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(A) What is the expected annual return of each investment?

(B) What is the standard deviation of the annual return of each investment?

(C) Calculate the correlations between all 4 investment returns.

(D) The investor is rather risk-averse and would like to pick two investments to limit his risks. Which two investments would you recommend if you were the advisor? Explain your choice.

(E) Please attach your work in an Excel spreadsheet

Economic Outcome Probability Return of Investment A Return of Investment B Return of Investment C Return of Investment D Rapid expansion 0.1 19.3 -9.1 2.5 -5.1 Moderate expansion 0.1 12.8 -4.3 1.3 -2 No growth 0.35 5.6 0.4 1 0.1 Moderate contraction 0.2 0.9 7.8 0.75 6 Serious contraction 0.25 -0.6 14.1 0.5 6.1

Explanation / Answer

a)

b)

c)

d)

the low value of sd indicates that mean is reliable. hence I prefer stock C and D.

excel sheet: replace " =" by "="

pi*Xi pi*Xi^2 Economic Outcome Probability Return of Investment A Return of Investment B Return of Investment C Return of Investment D A B C D A B C D Rapid expansion 0.1 19.3 -9.1 2.5 -5.1 1.93 -0.91 0.25 -0.51 37.249 8.281 0.625 2.601 Moderate expansion 0.1 12.8 -4.3 1.3 -2 1.28 -0.43 0.13 -0.2 16.384 1.849 0.169 0.4 No growth 0.35 5.6 0.4 1 0.1 1.96 0.14 0.35 0.035 10.976 0.056 0.35 0.0035 Moderate contraction 0.2 0.9 7.8 0.75 6 0.18 1.56 0.15 1.2 0.162 12.168 0.1125 7.2 Serious contraction 0.25 -0.6 14.1 0.5 6.1 -0.15 3.525 0.125 1.525 0.09 49.7025 0.0625 9.3025 sum 5.2 3.885 1.005 2.05 64.861 72.0565 1.319 19.507

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