a. What are investment returns? What is the return on an investment that costs $1,000 and is sold after 1 year for $1,100?

Estimated Returns on Alternative Investments State of the Economy Probability T-Bills Alta Industries Repo Men American Foam Market Portfolio 2-Stock Portfolio Recession 0.1 8.0% −22.0% 28.0% 10.0%a −13.0% 3.0%

Below average 0.2 8.0 −2.0 14.7 −10.0 1.0 Average 0.4 8.0 20.0 0.0 7.0 15.0 10.0 Above average 0.2 8.0 35.0 −10.0 45.0 29.0 Boom 0.1 8.0 50.0 −20.0 30.0 43.0 15.0 r^ 8.0% 1.7% 13.8% 15.0%

σ 0.0% 13.4% 18.8% 15.3%

CV 7.9 1.4 1.0 b −0.86 0.68 aNote that the estimated returns of American Foam do not always move in the same direction as the overall economy. For example, when the economy is below average, consumers purchase fewer mattresses than they would if the economy were stronger. However, if the economy is in a flat-out recession, a large number of consumers who were planning to purchase a more expensive inner spring mattress may purchase, instead, a cheaper foam mattress. Under these circumstances, we would expect American Foam’s stock price to be higher if there is a recession than if the economy was just below average.

Chapter 6: Risk, Return, and the Capital Asset Pricing Model 263