Hydra Capital offers a range of 1-year investment products for customers. The details for two such investment products are as follows:
“Investment A” is a security tied to market performance. For an initial investment of $100, the security, one year from today, will be worth:
- $140 if the market is “good”,
- $105 if the market is “moderate”, and
- $80 if the market is “bad”.
“Investment B” is a security also tied to the performance of the market. However, it performs better the worse the market is doing. For an initial investment of $100, the second security, one year from today, will be worth:
- $70 if the market is “good”
- $90 if the market is “moderate”, and
- $170 if the market is “bad”.
Bob is a prospective investor looking at Hydra Capital’s investment products. He has studied the market and concludes that over the coming year, there is a 30% chance the economy will be “good”, a 45% chance the market will be “moderate”, and a 25% chance the market will be “bad”.
Bob considers both products, and ultimately decides to spend $700 on “Investment A” and $300 on “Investment B” to construct his investment portfolio.
d) Determine the value of Bob’s portfolio after one year under each of the three possibilities for the market. Clearly label each case. (1 mark)
e) What is the expected return on Bob’s portfolio? (1 mark)
f) Calculate the variance and standard deviation of the return on Bob’s portfolio. (2 marks)