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Chapter 17: Q4. (page 369)
Tammy can buy an asset this year for \(1,000. She is expecting to sell it next year for \)1,050. What is the asset’s anticipated percentage rate of return?
0 percent
5 percent
10 percent
15 percent
The correct option is (b): 5%
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Consider an asset that costs \(120 today. You are going to hold it for 1 year and then sell it. Suppose that there is a 25 percent chance that it will be worth \)100 in a year, a 25 percent chance that it will be worth \(115 in a year, and a 50 percent chance that it will be worth \)140 in a year. What is its average expected rate of return? Next, figure out what the investment’s average expected rate of return would be if its current price were $130 today. Does the increase in the current price increase or decrease the asset’s average expected rate of return? At what price would the asset have a zero average expected rate of return?
Suppose that a risk-free investment will make three future payments of \(100 in one year, \)100 in two years, and $100 in three years. If the Federal Reserve has set the risk-free interest rate at 8 percent, what is the proper current price of this investment? What is the price of this investment if the Federal Reserve raises the risk-free interest rate to 10 percent?
Why is it so hard for actively managed funds to generate higher rates of return than passively managed index funds having similar levels of risk? Is there a simple way for an actively managed fund to increase its average expected rate of return?
Suppose that the city of New York issues bonds to raise money to pay for a new tunnel linking New Jersey and Manhattan. An investor named Susan buys one of the bonds on the same day that the city of New York pays a contractor for completing the first stage of construction. Is Susan making an economic or a financial investment? What about the city of New York?
Sammy buys stock in a suntan-lotion maker and also stock in an umbrella maker. One stock does well when the weather is good; the other does well when the weather is bad. Sammy’s portfolio indicates that “weather risk” is a _______ risk.
diversifiable
nondiversifiable
automatic
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