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EXPECTED RETURNS Suppose you won the lottery and had two options: (1) receiving $0.5 million or (2) taking a gamble in which, at the flip of a coin, you receive $1 million if a head comes up but receive zero if a tail comes up. a. What is the expected value of the gamble? b. Would you take the sure $0.5 million or the gamble? c. If you chose the sure $0.5 million, would that indicate that you are a risk averter or a risk seeker? d. Suppose the payoff was actually $0.5 million that was the only choice. You now face the choice of investing it in a U.S. Treasury bond that will return $537,500 at the end of a year or a common stock that has a 50-50 chance of being worthless or worth $1,150,000 at the end of the year. l. The expected profit on the T-bond investment is $37,500. What is the expected dollar profit on the stock investment? 2. The expected rate of return on the T-bond investment is 7.5%. What is the expected rate of return on the stock investment? 3. Would you invest in the bond or the stock? Why? 4. Exactly how large would the expected profit (or the expected rate of return) have to be on the stock investment to make you invest in the stock, given the 7.5% return on the bond? 5. How might your decision be affected if, rather than buying one stock for $0.5 million, you could construct a portfolio consisting of 100 stocks with $5,000 invested in each? Each of these stocks has the same return characteristics as the one stock that is, a 50-50 chance of being worth zero or $11,300 at year-end. Would the correlation between returns on these stocks matter? Explain.

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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781337395250
BuyFind

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781337395250

Solutions

Chapter
Section
Chapter 8, Problem 18P
Textbook Problem

EXPECTED RETURNS Suppose you won the lottery and had two options: (1) receiving $0.5 million or (2) taking a gamble in which, at the flip of a coin, you receive $1 million if a head comes up but receive zero if a tail comes up.

  1. a. What is the expected value of the gamble?
  2. b. Would you take the sure $0.5 million or the gamble?
  3. c. If you chose the sure $0.5 million, would that indicate that you are a risk averter or a risk seeker?
  4. d. Suppose the payoff was actually $0.5 million that was the only choice. You now face the choice of investing it in a U.S. Treasury bond that will return $537,500 at the end of a year or a common stock that has a 50-50 chance of being worthless or worth $1,150,000 at the end of the year.

l. The expected profit on the T-bond investment is $37,500. What is the expected dollar profit on the stock investment?

2. The expected rate of return on the T-bond investment is 7.5%. What is the expected rate of return on the stock investment?

3. Would you invest in the bond or the stock? Why?

4. Exactly how large would the expected profit (or the expected rate of return) have to be on the stock investment to make you invest in the stock, given the 7.5% return on the bond?

5. How might your decision be affected if, rather than buying one stock for $0.5 million, you could construct a portfolio consisting of 100 stocks with $5,000 invested in each? Each of these stocks has the same return characteristics as the one stock that is, a 50-50 chance of being worth zero or $11,300 at year-end. Would the correlation between returns on these stocks matter? Explain.

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Chapter 8 Solutions

Fundamentals of Financial Management (MindTap Course List)
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Ch. 8 - Suppose you owned a portfolio consisting of...Ch. 8 - The probability distribution of a less risky...Ch. 8 - A life insurance policy is a financial asset, with...Ch. 8 - Is it possible to construct a portfolio of...Ch. 8 - Stock A has an expected return of 7%, a standard...Ch. 8 - A stock had a 12% return last year, a year when...Ch. 8 - If investors aversion to risk increased, would the...Ch. 8 - If a companys beta were to double, would its...Ch. 8 - In Chapter 7, we saw that if the market interest...Ch. 8 - Suppose you own Stocks A and B. Based on data over...Ch. 8 - ABC Company's, stock earned a return of 10% this...Ch. 8 - EXPECTED RETURN A stocks returns have the...Ch. 8 - PORTFOLIO BETA An individual has 20,000 invested...Ch. 8 - REQUIRED RATE OF RETURN Assume that the risk-free...Ch. 8 - EXPECTED AND REQUIRED RATES OF RETURN Assume that...Ch. 8 - BETA AND REQUIRED RATE OF RETURN A stock has a...Ch. 8 - EXPECTED RETURNS Stocks A and B have the following...Ch. 8 - PORTFOLIO REQUIRED RETURN Suppose you are the...Ch. 8 - BETA COEFFICIENT Given the following; information,...Ch. 8 - REQUIRED RATE OF RETURN Stock R has a beta of 2.0,...Ch. 8 - CAPM AND REQUIRED RETURN Beale Manufacturing...Ch. 8 - CAPM AND REQUIRED RETURN Calculate the required...Ch. 8 - REQUIRED RATE OF RETURN Suppose rRF = 4%, rM =...Ch. 8 - CAPM, PORTFOLIO RISK, AND RETURN Consider the...Ch. 8 - PORTFOLIO BETA Suppose you held a diversified...Ch. 8 - CAPM AND REQUIRED RETURN HR Industries (HRI) has a...Ch. 8 - CAPM AND PORTFOLIO RETURN You have been managing a...Ch. 8 - PORTFOLIO BETA A mutual fund manager has a 20...Ch. 8 - EXPECTED RETURNS Suppose you won the lottery and...Ch. 8 - EVALUATING RISK AND RETURN Stock X has a 10%...Ch. 8 - REALIZED RATES OF RETURN Stocks A and B have the...Ch. 8 - SECURITY MARKET LINE You plan to invest in the...Ch. 8 - EVALUATING RISK AND RETURN Bartman Industrie's...Ch. 8 - RISK AND RETURN Assume that you recently graduated...Ch. 8 - Using Past Information to Estimate Required...Ch. 8 - Using Past Information to Estimate Required...Ch. 8 - Using Past Information to Estimate Required...Ch. 8 - Using Past Information to Estimate Required...Ch. 8 - Using Past Information to Estimate Required...Ch. 8 - Using Past Information to Estimate Required...Ch. 8 - Using Past Information to Estimate Required...Ch. 8 - Using Past Information to Estimate Required...

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