If You Invest $100 Now in Firm A, in One

question 16

Essay

If you invest $100 now in firm A, in one year you will get back $(30 + T), where T is the average temperature during the next summer. If you invest $100 now in firm B, in one year you will get back $(180 - T). The expected value of T is 70 and the standard deviation of T is 10.
a. Draw a graph showing the combinations of expected return and standard deviation that you can have by dividing $100 between stock in A and stock in B. (Hint: Expected value has the property that E(ax + b) = aE(x) + b and standard deviation has the property that SD(ax + b) = [(absolute value of a) times SD(x)] +b).
b. What is the expected value and standard deviation of the safest investment strategy you can make by this means?
c. What is the highest expected value you can achieve?

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Definitions:

Stock Price

The current price at which a share of a company can be bought or sold on the stock market.

Dividend Growth Rate

Dividend Growth Rate is the annualized percentage rate of growth of a company's dividend payments over time.

Investor's Return

The profit or loss realized on an investment over a specified period, often expressed as a percentage of the investment’s initial cost.

Stock Price

The cost of purchasing a share of a company's stock, which fluctuates based on supply and demand in the marketplace.