Consider Three Alternative Bonds That You Might Invest In, Each

question 59

Essay

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.For example, if you buy bond A, the probability is
90 percent that your return will be 20 percent and the probability is 10 percent that your return will be ?100 percent
(in other words, you lose the entire amount invested). $$\begin{array} { l l l } \text { Band } & \text { Prabability } & \text { Roturn } \\\text { Bund A } & 90 \% & 20 \% \\& 10 \% & - 100 \% \\& & \\\text { Band B } & 75 \% & 40 \% \\& 25 \% & - 40 \% \\& & \\\text { Bund C } & 60 \% & 10 \% \\&40\%&-10\%\end{array}$$
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?
Explain and show all your work.In your calculations, you may round after three significant digits.

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Definitions:

AQL

Acceptable Quality Level, a statistical measurement used in quality control that defines the maximum number of defective items allowed in a sample lot.

Type II Error

Statistically, the probability of accepting a bad lot.

Bad Lot

A batch of products that fails to meet quality specifications or standards, often leading to rejection or rework.

LTPD

The Lot Tolerance Percent Defective, which refers to the maximum acceptable defect rate in a sample lot for the lot to be accepted.