Topic for Discussion: “Risk and Return”
GDB Question:
Assume that you are recently graduated with majors in finance, and you just want to invest Rs. 100,000 in a business at the end of year 1. You are interested to plan for a 1-year holding period. Further, you have got the following information from market about different investment alternatives, which is shown with their probabilities and associated outcomes.
Returns on Alternative Investments
Estimated Rate of Returns
| ||||||
Economy activity level
|
Probability
|
T-Bills
|
A
|
B
|
C
|
Market Return
|
Recession
|
0.3
|
10.0%
|
(22.0%)
|
28.0%
|
10.0%
|
(13.0%)
|
Normal
|
0.4
|
10.0%
|
20.0 %
|
0.0
|
7.0%
|
15.0%
|
Boom
|
0.3
|
10.0%
|
50.0%
|
(20.0%)
|
30.0%
|
43.0%
|
Expected returns
R* = ∑PiRi
|
1.0
|
10.0%
|
16.4%
|
2.4%
|
14.8%
|
15%
|
Discuss the following:
a. Why T-bill’s returns do not change with change in the economy activity level?
b. “T-bills returns are the risk-free”, comment on the statement.
c. Why do A’s expected returns move with the economy? Explain with logical reasoning.
d. Why do B’s expected returns move counter to the econo
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