Assume that you recently graduated with a major in finance and that you just landed a job as a

financial planner with Barney Smith Inc., a large financial services corporation. Your first

assignment is to invest $$100,000$ for a client. Because the funds are to be invested in a new

business that the client plans to start at the end of $1$ year, you have been instructed to plan

for a $1-$year holding period. Further, your boss has restricted you to the investment alternatives

shown in the table below. $($Disregard for now the items at the bottom of the data; you

will fill in the blanks later.$)$

Barney Smith$$s economic forecasting staff has developed probability estimates for the

state of the economy, and its security analysts have developed a sophisticated computer

program that was used to estimate the rate of return on each alternative under each

state of the economy. Alta Industries is an electronics firm; Repo Men Inc. collects

past$-$due debts; and American Foam manufactures mattresses and various other foam

products. Barney Smith also maintains an $$index fund$$ that owns a market$-$weighted

fraction of all publicly traded stocks; you can invest in that fund and thus obtain

average stock market results. Given the situation as described, answer the following

questions.

${?}^a$ Note 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.

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?$

Options

b$.(1)$ Why is the T$-$bill's return independent of the state of the economy? Do T$-$bills

promise a completely risk$-$free return? $(2)$ Why are Alta Industries's returns expected

to move with the economy whereas Repo Men's are expected to move counter to

the economy?