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Chapter 17: Q6. (page 369)

An investment has a 50 percent chance of generating a 10 percent return and a 50 percent chance of generating a 16 percent return. What is the investment鈥檚 average expected rate of return?

  1. 10 percent

  2. 11 percent

  3. 12 percent

  4. 13 percent

  5. 14 percent

  6. 15 percent

  7. 16 percent

Short Answer

Expert verified

The correct option is (d): 13 percent

Step by step solution

01

Step 1. Explanation

The average expected rate of return is calculated below:

E=0.5脳10%+0.5脳16%=5%+8%=13%

The average expected rate of return is 13%.

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Most popular questions from this chapter

Why is it so hard for actively managed funds to generate higher rates of return than passively managed index funds having similar levels of risk? Is there a simple way for an actively managed fund to increase its average expected rate of return?

Identify each of the following investments as either an economic investment or a financial investment.

a. A company builds a new factory.

b. A pension plan buys some Google stock.

c. A mining company sets up a new gold mine.

d. A woman buys a 100-year-old farmhouse in the countryside.

e. A man buys a newly built home in the city.

f. A company buys an old factory.

Consider an asset that costs \(120 today. You are going to hold it for 1 year and then sell it. Suppose that there is a 25 percent chance that it will be worth \)100 in a year, a 25 percent chance that it will be worth \(115 in a year, and a 50 percent chance that it will be worth \)140 in a year. What is its average expected rate of return? Next, figure out what the investment鈥檚 average expected rate of return would be if its current price were $130 today. Does the increase in the current price increase or decrease the asset鈥檚 average expected rate of return? At what price would the asset have a zero average expected rate of return?

What is compound interest? How does it relate to the formula Xt = (1 + i)t X0? What is present value? How does it relate to the formula Xt/(1 + i)t = X0?

The U.S. government issues longer-term bonds with horizons of up to 30 years. Why do 20-year bonds issued by the U.S. government have lower rates of return than 20-year bonds issued by corporations? And which do you think has the higher rate of return, longer-term U.S. government bonds or short-term U.S. government bonds? Explain.
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