You should recognize that basing a decision solely on expected returns is appropriate only for risk-neutral individuals.

Question:

You should recognize that basing a decision solely on expected returns is appropriate only for risk-neutral individuals. Because your client, like virtually everyone, is risk averse, the riskiness of each alternative is an important aspect of the decision. One possible measure of risk is the standard deviation of returns.

(1) Calculate this value for each alternative, and fill in the blank in the row for Ïƒ in the table.

(2) What type of risk is measured by the standard deviation?

(3) Draw a graph that shows roughly the shape of the probability distributions for Alta Industries, American Foam, and T-bills.

Assume that you recently graduated with a major in finance, and you just landed a job as a financial planner with Barney Smith Inc., a large financial services corporation. Your first assignment is to invest $100,000 for a client. Because the funds are to be invested in a business at the end of 1 year, you have been instructed to plan for a 1-year holding period. Further, your boss has restricted you to the investment alternatives shown in the table with their probabilities and associated outcomes. (Disregard for now the items at the bottom of the data; you will fill in the blanks later.) Barney Smith's economic forecasting staff has developed probability estimates for the state of the economy, and its security analysts have developed a sophisticated computer program that was used to estimate the rare of return on each alternative under each state of the economy. Alta Industries is an electronics firm; Repo Men Inc. collects past-due debts; and American Foam manufactures mattresses and various other foam products. Barney Smith also maintains an "index fund" that owns a market-weighted fraction of all publicly traded stocks; you can invest in that fund, and thus obtain average stock market results. Given the situation as described, answer the followingquestions.