Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

PROBLEM 2: Suppose there are three equally likely outcomes or scenarios for the economy: a recession, normal growth, and a boom. An investment in auto

image text in transcribed
PROBLEM 2: Suppose there are three equally likely outcomes or scenarios for the economy: a recession, normal growth, and a boom. An investment in auto stock will have a rate of return of 8% in a recession, 5% in a normal period, and 18% in a boom. Also, suppose that a stock in a gold mining firm will provide a rate of return of 20% in a recession, 3% in a normal period, and 20% in a boom. [10 points] (a) Firms that do well when the economy does well are called cyclical whilst firms that have the opposite performance in their rate of return are called countercyclical. Based on the given information above, classify the auto and gold stocks as either cyclical or countercyclical. [1 pt] (b) Which stock investment is more volatile and why? Reason out based on the concept of variation. [1 pf] (c) Confirm your answer in (b) by measuring the standard deviation of returns of the two assets. [4 pts] (d) Compute the correlation between the auto and gold stocks. [ 1pt ] (e) Suppose the probabilities of the recession or boom are 0.30. Would you expect the variance of returns on these two investments to be higher or lower and why? Use general economic/statistical principle(s). [ 1 pt] (f) Confirm your answer in (e) by calculating the standard deviation of the auto stock. [2 pts]

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Principles Of Project Finance

Authors: E.R. Yescombe

1st Edition

0127708510, 978-0127708515

More Books

Students also viewed these Finance questions

Question

A bargain is unconscionable if it is grossly unfair. True or False

Answered: 1 week ago