EXPECTED RETURNS

Suppose you won the lottery and had two options: (1) receiving $1.8 million or (2) taking a gamble in which, at the flip of a coin, you receive $3.6 million if a head comes up but receive zero if a tail comes up.

a. What is the expected value of the gamble? (Round to two decimal places)

b. Suppose the payoff was actually $1.8 million - that was the only choice. You now face the choice of investing it in a U.S. Treasury bond that will return $1,917,000 at the end of a year or a common stock that has a 50-50 chance of being worthless or worth $4,320,000 at the end of the year.

1. The expected profit on the T-bond investment is $117,000. What is the expected dollar profit on the stock investment? (Round to two decimal places)

2. The expected the rate of return on the T-bond investment is 6.5%. What is the expected rate of return on the stock investment? (Round to two decimal places)

3. Exactly how large would the expected profit (or the expected rate of return) have to be on the stock investment to make you invest in the stock, given the 6.5% return on the bond? (Round to two decimal places)