Question

Suppose the​ risk-free interest rate is 3 %​, and the stock market will return either plus 34 % or negative 19 % each​ year, with each outcome equally likely. Compare the following two investment​ strategies: (1) invest for one year in the​ risk-free investment, and one year in the​ market, or​ (2) invest for both years in the market.

a. Which strategy has the highest expected final​ payoff?

b. Which strategy has the highest standard deviation for the final​ payoff?

c. Does holding stocks for a longer period decrease your​risk?

Answer 1

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- 2x % Cut vy 91 or 93 PE EPS, STOCK DIVIDEND - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins Σ AutoSum : A Calibri -11AA = = = Dr Wrap Text General E Copy Fill Paste BIU - D A Merge & Center - Merge & Center - $ -% $ % ; 8 Format Painter .9 Conditional Format Cell Insert Delete Format Sort & Find & Formatting as Table Styles 2 Clear Filter Select Clipboard Font Alignment Number Styles Cells Editing VL89 | UK VL VM VN vo VP va FR vs VT vu v w x 89 90 a strategy 1 invest for 1 year in risk free investment and 1 year in market return = (1+0.03) *(1+0.34) - 1 = 38.02% 38.0% 92 or (1+0.03) *(1 -0.19) - 1 = -16.57% -16.6% 94 95 strategy 2 invest for both the years in market 96 return = (1+0.34) *(1+0.34) - 1 = 79.56% 79.6% 97 or 98 (1-0.19) *(1 -0.19) - 1 = -34.39% -34.4% 99 or or 100 (1+0.34) *(1-0.19) - 1 = 8.54% 8.54% 101 or or 102 (1-0.19) *(1+0.34) - 1 = 8.54% 8.54% 103 104 expected payoff under strategy 1 = (38.02% -16.57%)/2 = 10.7250% 10.7% 105 expected payoff under strategy 2 = (79.56% +(-34.39%) + 8.54% + 8.54%)/4= 15.5625% 15.6% highest expected payoff under strategy 2 : invest both the years in market 107 108 b standard deviation (SD) under both strategies 109 H HIGH LOW TARGET PRICE STOCK DIV NAV HEDGE FUND ME EV PE EPS DIV ABNORMAL deberk MARGIN MONEY marginal tax PB ROPI APV ROSS price quote EVA MVAJ Sel 10 nd press ENTER or choose Paste BO. 120% 106 DO 4 ...ll * 4 OENG * 21-11-2019

- 2x AutoSum A Σ AutoSum : A Fill Sort & 2 Clear Filter Editing Find & Select PE EPS, STOCK DIVIDEND - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins % Cut Calibri 11AA = = = Dr Wrap Text General 1 LA Ea Copy Paste B I U - - E A = 5 st Fat Merge Merge & Center - Center $ $ -% Format Painter % , , .0 .00 ;. Conditional Format Cell Insert Delete Format Formatting as Table Styles Clipboard Font Alignment Number Styles Cells VP119 - UK VL VM VN vo VP va FR vs VT vu v 108 b standard deviation (SD) under both strategies 109 110 strategy 1 SD = sqrt(1/2(38.02%-10.7250%)^2+1/2(-16.57%-10.7250%)^2) = 111 27.2950% 112 vw vx vy 27.3% 113 strategy 2 SD = sqrt(1/4(79.56%-15.5625%)^2 + 1/4(-34.39%-15.5625%)^2 + 1/4(8.54%-15.5625%)^2 + 1/4(8.54%-15.5625%)^2) = 40.8949% 40.9% 114 115 116 117 118 c No 119 120 121 122 123 124 125 126 127 128 NON HIGH LOW TARGET PRICE Rea 1 ferences STOCK DIV NAV HEDGE FUND ME EV PE EPS DIV ABNORMAL deberk MARGIN MONEY marginal tax PB ROPI APV ROSS price quote EVA MVAJ BO. 120% B A .lll 21-11-2019