Consider three alternative bonds that you might invest in, each of which matures in one year. The following table shows the probability that you will receive each possible return.
|
|
Bond
|
Probability
|
Return
|
|
|
Bond A
|
90%
|
20%
|
|
|
|
10%
|
-100%
|
|
|
|
|
|
|
|
Bond B
|
75%
|
40%
|
|
|
|
25%
|
-40%
|
|
|
|
|
|
|
|
Bond C
|
60%
|
10%
|
|
|
|
40%
|
-10%
|
a. Calculate the expected return for all three bonds in percentage terms.
b. The standard deviations of the returns on these bonds are: Bond A, 36.0 percent; Bond B, 34.6 percent; Bond C, 9.8 percent. If you are extremely risk averse, which of the three bonds would you buy? Why?
c. Would a risk-averse investor ever buy Bond A instead of one of the other bonds? Why or why not?
d. Explain and show all your work. In your calculations, you may round after three significant digits.