Q.A company will earn net profits of $100,000 if the economy booms (probability of 80%) and net profits of $60,000 if the economy enters a recession (probability of 20%). The company wants to take out a loan for $74,000 to finance its operations.Treasuries of the same maturity offer an interest rate of 6%. Assume risk neutrality. A)What payoff would the bank receive if it invested $74,000 in Treasuries? B)What payout should the bank be looking for during the boom (in $)? C)What interest rate should the bank quote?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Q.A company will earn net profits of $100,000 if the economy booms (probability of 80%) and net profits of $60,000 if the economy enters a recession (probability of 20%). The company wants to take out a loan for $74,000 to finance its operations.Treasuries of the same maturity offer an interest rate of 6%. Assume risk neutrality.
A)What payoff would the bank receive if it invested $74,000 in Treasuries?
B)What payout should the bank be looking for during the boom (in $)?
C)What interest rate should the bank quote?
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