You are given an opportunity to invest in an asset. When the economy is in a boom, any dollar that you invest in that asset will grow to $1.125 at the end of the year. During busts, however, you will lose $0.05 per any dollar that you invest. This means that during busts you will end up with $0.95 at the end of the year. (You may assume that inflation rate is at zero percent if you wish; don’t worry about any loss in your purchasing power).
You do not invest in the above asset if you believe that the economy is going to end up in a boom next year with probability of _____, and that the economy is going to end up in a bust next year with probability of _____.
a) 35%; 65%
b) 30%; 70%
c) 25%; 75%
d) Options A and B
e) Options B and C
Compute the standard deviation of the above investment if you believe that the economy is going to end up in a boom next year with probability of 60%, and that the economy is going to end up in a bust next year with probability of 40%.
a) $0
b) $0.086
c) $0.18
d) $0.274
e) $0.50