Investment and Normal Economy

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| =5 – .

| $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. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 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. 3333×1. 541819| | | | | | | | | Normal economy| 33. 33%| 27. 5%| 9. 17%| 1. 67%| 0. 000279| 0. 000093| | | | | | | | | Recession| 33. 33%| -100%| -33. 3%| -125. 83%| 1. 583319| 0. 527720| | | | | | | | | Total| | | 25. 83%| | | 1. 041701| | | | | | | | | | | | | | | | | | | | | | | | Probability = 1/3 as all the three states are equally likely| | | | | | | | | | | | | | | | | | | | | | | | | | Expected return=| 0. 2583| or| 25. 83%| | | | | | | | | | | Variance=| | 1. 041701| | | | | | | | | | | | | Standard deviation=vVariance=| 1. 0206| or| 102. 06%| =v1. 041701| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Question:| | | | | | | | | | | | | | | | | | | | | | | | | | | | | Portfolio Risk. Who would view the stock of Learning Tower of Pita as a risk reducing investment – the owner of a gambling casino or a successful bankruptcy lawyer? Explain.

| | | | | | | | | | | | | | | | | A successful bankruptcy lawyer would view stock of leaning Tower Of Pta a risk reducing investment because in recession his business would do well and Leaning Tower of Pita would not whereas, in boom times his business would not do well but Leaning Tower of Pita would do well. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |