Reference no: EM133068853
Suppose you won the lottery and were offered a choice of $500,000 in cash or a gamble in which you could win $1 million based on a coin toss-heads you win, tails you lose. And now suppose you take $500,000. You can invest it in either an Australian Treasury bond that will return $537,500 at the end of one year or a company share that has a 50:50 chance of being either worthless or worth $1,150,000 at the end of the year.
a)What is the expected dollar profit on the security investment?(The expected profit on the T-bond investment is $37,500)
b) What is the expected rate of return on the security investment? (The expected rate of return on the T-bond investment is 7.5 percent)
c)Would you invest in the bond or the security?
d)Exactly how large would the expected profit (or the expected rate of return) have to be on the share investment to make you invest in the share, given the 7.5 per cent return on the bond?
e) How might your decision be affected if, rather than buying one share for $500,000, you could construct a portfolio of 100 securities with $5,000 invested in each? Each of these securities has the same return characteristics as the one share- that is, a 50:50 chance of being worth either zero or $11,500 at year end. Would the correlation between returns on these shares matter?
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