An investor is debating which of two investments to pursue: a stock or a bond. The...
An investor is debating which of two investments to pursue: a stock or a bond. The stock investment is more risky in terms of having more downside (and upside) potential, depending on future market conditions which are uncertain at this time. The stock is projected to earn a $16,000 profit if market conditions are favorable but will result in a $11,000 loss if market conditions are unfavorable. The bond is projected to earn a $8,500 profit if market conditions are favorable or a $3,000 loss if market conditions are unfavorable. At this time, the probability of favorable market conditions is estimated to be 0.50, and the probability of unfavorable market conditions is estimated to be 0.50.
a. Compute the expected profit for the stock investment.
Enter your answer as a whole number.
Expected profit for stock investment = $ ___________
b. Compute the expected profit for the bond investment.
Enter your answer as a whole number.
Expected profit for bond investment = $ ___________
c. Assume that the investor is "risk neutral." "Risk neutral" means that he/she makes decisions based only on the expected value of the decision under consideration. In this case, which alternative (stock or bond) should the investor choose?
A). Bond investment
B.) Stock investment
Homework Answers
a) Expected profit for stock investment = 0.5x16000 - 0.5x11000
= $2500
b) Expected profit for bond investment = 0.5x8500 - 0.5x3000
= $2750
c) B. Stock investment
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QUESTION 18
Which of the following statements is CORRECT?
1.
An investor can eliminate virtually all diversifiable risk if
he or she holds a very large, well-diversified portfolio of
stocks.
2.
Once a portfolio has about 40 stocks, adding additional stocks
will not reduce its risk by even a small amount.
3.
It is impossible to have a situation where the market risk of
a single stock is less than that of a portfolio that includes the
stock.
4.
An...
3. The probability that a Wall Street stock market investor will sell his stocks at a profit of $7000 is 0.19, the probability to sell at a profit of $4000 is 0.38, the probability to break even is 0.32 and the probability that he will sell at a loss of $5000 is 0.11. What is his expected profit? 4. A small company must decide whether to merge with a larger company to make more investments. If they merge and it...
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QUESTION 18
Which of the following statements is CORRECT?
1.
An investor can eliminate virtually all diversifiable risk if
he or she holds a very large, well-diversified portfolio of
stocks.
2.
Once a portfolio has about 40 stocks, adding additional stocks
will not reduce its risk by even a small amount.
3.
It is impossible to have a situation where the market risk of
a single stock is less than that of a portfolio that includes the
stock.
4.
An...
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