Reference no: EM131050921
Suppose you have just inherited $10,000 and are considering the following options for investing the money to maximize your return:
Option 1: Put the money in an interest-bearing checking account, which earns 2%. The FDIC insures the account against bank failure.
Option 2: Invest the money in a corporate bond, with a stated return of 5%, but there is a 10% chance the company could go bankrupt.
Option 3: Loan the money to one of your friends’ roommates, Mike, at an agreed-upon interest rate of 8%, but you believe there is a 7% chance that Mike will leave town without repaying you.
Option 4: Hold the money in cash and earn zero return.
a. If you are risk-neutral (that is, neither seek out nor shy away from risk), which of the four options should you choose to maximize your expected return? (Hint: To calculate the expected return of an outcome, multiply the probability that an event will occur by the outcome of that event).
b. Suppose Option 3 is your only possibility. If you could pay your friend $100 to find out extra information about Mike that would indicate with certainty whether he will leave town without paying or not, would you pay the $100? What does this say about the value of better information regarding risk?
|
What is the best estimate of these bonds remaining life
: Lloyd Corporation's 12% coupon rate, semi-annual payment, $1,000 par value bonds, which mature in 25 years, are callable 6 years from today at $1,025. They sell at a price of $1,278.56, and the yield curve is flat. Assume that interest rates are expe..
|
|
What interest rate would the investment have to yield
: Stanley Roper has $2,400 that he is looking to invest. His brother approached him with an investment opportunity that could give Patrick $4,600 in 4 years. What interest rate would the investment have to yield in order for Stanley’s brother to delive..
|
|
Money has different values based on time
: Money has different values based on time. Money in your pocket has a current value, but money owed to you has a varying value based on how sure it is that you will receive it and when. It is possible to estimate its value. In this assignment, you wil..
|
|
What do these results indicate about investor expectations
: How does inflation impact returns? In this example, you will see how the Fisher equation can be used to determine the best investment option. Suppose Jim has $2,000 to invest and he is not sure what will happen to inflation over the coming year, but ..
|
|
Options for investing the money to maximize your return
: Suppose you have just inherited $10,000 and are considering the following options for investing the money to maximize your return: Put the money in an interest-bearing checking account, which earns 2%. The FDIC insures the account against bank failur..
|
|
The annual debt service payment
: Assume the rate on the issuance of $100m of 100-year bonds is 7.5%; the annual debt service payment would be $7.505m. How high would the interest rate have to be on 30-year bonds for the annual debt service payment to be the same for both financings?
|
|
Project net present value if the required rate of return
: A project is expected to create operating cash flows of $24,000 a year for three years. The initial cost of the fixed assets is $50,000. These assets will be worthless at the end of the project. An additional $2,500 of net working capital will be req..
|
|
Explain why correlations of these firms are expected to low
: Diversification occurs when stocks with low correlations of returns are placed together in a portfolio. Identify at least one type of firm that might exhibit low correlations of returns with the overall stock market? Explain why the correlations of t..
|
|
Price of the shorter-term bond when interest rates change
: Bond valuation An investor has two bonds in his portfolio that both have a face value of $1,000 and pay a 7% annual coupon. Bond L matures in 15 years, while Bond S matures in 1 year. What will the value of the Bond L be if the going interest rate is..
|