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 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. What is the difference between systematic and non-systematic risk? Evaluate the two strategies adopted by financial institution to manage their risks.
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 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. What is the difference between systematic and non-systematic risk? Evaluate the two strategies adopted by financial institution to manage their risks.
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
Problem 1PS
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Could part 2 be answered
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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