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You have $200 to invest, and you are considering two stocks. In the next year, each stock will either have a return of +20% or
You have $200 to invest, and you are considering two stocks. In the next year, each stock will either have a return of +20% or -6%. Assume as well that the performance of one stock is unrelated to the performance of the other (in other words, the stock returns are uncorrelated). The following table shows the resulting four possibilities, depending on whether each of the two stocks gains or loses value. (To read the table, note that the first outcome listed in each cell is for Stock 1 and the second outcome in each cell is for Stock 2.) Stock 2 Gain Stock 1 Gain Stock 1 Gain, Stock 2 Gain Stock Lose, Stock 2 Gain Lose Stock 1 Gain, Stock 2 Lose Stock 1 Lose, Stock 2 Lose Lose Assume that each of the four possibilities has a 25% chance of occurring and that the probability of either stock gaining value is 50%. If you put all of your money into Stock 1 or Stock 2, the average return that you will receive is%. (Enter your response as an integer.) Hint: average the returns of + 20% and - 6% If you split your money equally between the two stocks ($100 in Stock 1 and $100 in Stock 2), what would be your total return at the end of the year in each of the boxes above? Fill out the following table to indicate the total return you would have in each of the four possible situations. (Enter your responses as integers.) Hint: average the returns of the two investments in each box. Stock 2 Lose Gain % Gain Stock 1 % % Lose % If you split your money between the two stocks, the average return that you will receive is %. (Enter your response as an integer.) Hint: take the total return for each box recorded above and calculate the average across the four boxes, giving each box equal weight Is there any benefit in splitting your money between the two stocks? O A. No, the return from splitting is identical to the return from putting all $200 into Stock 1 or Stock 2. OB. Yes, the volatility of the return is diminished with diversification even if the expected return is unaltered
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