You own a well-diversified portfolio. You are considering a small investment in a local start-up founded by a family member. 

 

Your best guess is that the start-up has a 30% chance of succeeding in which case the return is estimated to be 400%--and a 70% chance of failing, in which case you will lose your entire investment (i.e., the return will be -100%.)

 

The current risk-free rate is 2% per year, and the expected market risk premium is 6% per year.

a.  Calculate the expected return on the investment.

b.  Calculate the standard deviation of return on this investment.

c. Is this a valuable investment opportunity? Explain your answer and use calculations, where appropriate, to make your point.

Answer rating: 100% (QA)

a To calculate the expected return on the investment we need to multiply the probabilities of each outcome by their corresponding returns and sum them ... View the full answer