Investment and Normal Economy

Topics: Investment, Stock, Bond Pages: 2 (334 words) Published: November 21, 2011
Portfolio Risk| | | | | | | | | | | | | |
Scenario Analysis.  The common stock of Leaning Tower of Pita, Inc., a restaurant chain, will generate the following payoffs to investors next year:| | | | | | | | | | | | | | | | |

| | Dividend| Stock price| | | | | | | | | | | | Boom| | 5| 195| | 150.00%| | | | | | | | | | Normal economy| 2| 100| | 27.50%| | | | | | | | | | Recession| | 0| 0| | -100.00%| | | | | | | | | | | | | | | | | | | | | | | | |

The company goes out of business if a recession hits.  Calculate the expected rate of return and standard deviation of return to Learning Tower of Pita shareholders.  Assume for simplicity that the three possible states of the economy are equally likely.  The stock is selling today for $80.| | | | | | | | | | | | | | | | |

Current stock price=| $80| | | | | | | | | | | | | | | | | | | | | | | | | | | |
 |  | Dividend| Stock price| Capital gains|  | Total gain (dividend + capital gain)|  | Return|  |  | | | | | Boom| | $5| $195| $115| =$195 - $80.| $120| =$5 + $115.| 150.00%| =$120 / $80.| 25.83%| | | | Normal economy| $2| $100| $20| =$100 - $80.| $22| =$2 + $20.| 27.50%| =$22 / $80.| | | | | Recession|  | $0| $0| -$80| =$ - $80.| -$80| =$ -$80.| -100.00%| =-$80 / $80.| | | | | | | | | | | | | | | | | | | |

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Scenario| Probability| return| return x Probability| Difference from mean, i.e.0.2583| Difference 2 | Probability x Difference 2| | | 25.83%| | | | | | Boom| 33.33%| 150%| 50.00%| 124.17%| 1.541819| 0.513888| | | | | | | | |  |  |  | =150.%x0.3333| =150.%-25.83%| =1.2417^2| =0.3333x1.541819| | | | | | | | | Normal economy| 33.33%| 27.5%| 9.17%| 1.67%| 0.000279| 0.000093| | | |...
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