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Consider the two risky investments below: Scenario Asset 1 Asset 2 Probability | Returns 0.1 Probability 0.1 Returns Depression -30% Recession 0.2 -10% 0.2 5% Normal 0.5 20% 0.5 20% Boom 0.2 50% 0.2 -5% a) What is the erpected return and the standard deviation of returns to each investment?

Consider the two risky investments below: Scenario Asset 1 Asset 2 Probability | Returns 0.1 Probability 0.1 Returns Depression -30% Recession 0.2 -10% 0.2 5% Normal 0.5 20% 0.5 20% Boom 0.2 50% 0.2 -5% a) What is the erpected return and the standard deviation of returns to each investment?

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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i. Consider the two risky investments below: Scenario Asset 1 Asset 2 Probability Returns Probability Returns Depression Recession 0.1 -30% 0.1 0.2 -10% 0.2 5% Normal 0.5 20% 0.5 20% Boom 0.2 50% 0.2 -5% a) What is the expected return and the standard deviation of returns to each investment? b) If the expected return on the market portfolio is 12% and the risk-free rate is 6%. What is the expected return using CAPM for the above two assets? Assume that beta of Asset 1 is 0.2 and Asset 2 is 1.4? c) Suppose that the correlation between the returns is -0.039 estimated in part a of this questions. Produce a chart showing alternative risk-return combinations from the two investments. You can start by using 0.1 and 0.9 capital allocation to investment and continue changing it by a 10% differential. ii. What is the difference between systematic and non-systematic risk? iii. Evaluate the two strategies adopted by financial institution to manage their risks.
Transcribed Image Text:i. Consider the two risky investments below: Scenario Asset 1 Asset 2 Probability Returns Probability Returns Depression Recession 0.1 -30% 0.1 0.2 -10% 0.2 5% Normal 0.5 20% 0.5 20% Boom 0.2 50% 0.2 -5% a) What is the expected return and the standard deviation of returns to each investment? b) If the expected return on the market portfolio is 12% and the risk-free rate is 6%. What is the expected return using CAPM for the above two assets? Assume that beta of Asset 1 is 0.2 and Asset 2 is 1.4? c) Suppose that the correlation between the returns is -0.039 estimated in part a of this questions. Produce a chart showing alternative risk-return combinations from the two investments. You can start by using 0.1 and 0.9 capital allocation to investment and continue changing it by a 10% differential. ii. What is the difference between systematic and non-systematic risk? iii. Evaluate the two strategies adopted by financial institution to manage their risks.
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