3. Consider three alternative bonds that you might invest in, each of which matures in one year. The following table shows the probability that you will receive each possible return. For example, if you buy bond A, the probability is 90 percent that your return will be 20 percent and the probability is 10 percent that your return will be 100 percent.
Bond Probability Return Bond A 90% 20% 10% -100% Bond B 75% 40% 25% -40% Bond C 60% 10% 40% -10%
a. Calculate the expected return for all three bonds in percentage terms.
b. Calculate the standard deviations of the returns on these bonds. If you are extremely risk-averse, which of the three bonds would you buy? Why?
c. Would a risk-averse investor ever buy Bond A instead of one of the other bonds? Why or why not?
3. Consider three alternative bonds that you might invest in, each of which matures in one year. The following table shows the probability that you will receive each possible return. For example, if you buy bond A, the probability is 90 percent that your return will be 20 percent and the probability is 10 percent that your return will be 100 percent.
Bond Probability Return Bond A 90% 20% 10% -100% Bond B 75% 40% 25% -40% Bond C 60% 10% 40% -10%
a. Calculate the expected return for all three bonds in percentage terms.
b. Calculate the standard deviations of the returns on these bonds. If you are extremely risk-averse, which of the three bonds would you buy? Why?
c. Would a risk-averse investor ever buy Bond A instead of one of the other bonds? Why or why not?
