Question

  James Fromholtz is considering whether to invest in a newly formed investment fund. The​ fund's investment objective is to acquire home mortgage securities at what it hopes will be bargain prices. The fund sponsor has suggested to James that the​ fund's performance will hinge on how the national economy performs in the coming year. ​ Specifically, he suggested the following possible​ outcomes:

State of Economy	Probability		Fund Returns
Rapid expansion and recovery	5​%		100​%
Modest growth	35​%		30​%
Continued recession	55​%		20​%
Falls into depression	5​%		−100​%

a.  Based on these potential​ outcomes, what is your estimate of the expected rate of return from this investment​ opportunity?

b.  Calculate the standard deviation in the anticipated returns found in part a

c.  Would you be interested in making such an​ investment? Note that you lose all your money in one year if the economy collapses into the worst state or you double your money if the economy enters into a rapid expansion.

Answer 1