Suppose a Discount Bond Costs $5,000 Today and Pays Off

Essay

Suppose a discount bond costs $5,000 today and pays off some amount b in one year.Suppose that b is uncertain according to the following table of probabilities: $$\begin{array} { l l l l l l } \text { b: } & \$ 5,000 & \$ 5,500 & \$ 6,000 & \$ 6,500 & \$ 7,000 \\\text { Probability. } & 0.1 & 0.2 & 0.3 & 0.2 & 0.2\end{array}$$
a.Calculate the return (in percent) for each value of b. (Note: you may just calculate the total return and not worry about how this is split up between current yield and capital-gains yield.)

b.Calculate the expected return.
Suppose an investor has a choice between buying this security or purchasing a different
b.(Note: you may just calculate the total return and not worry about how this is split up between current yield and capital-gains yield.)

c.Suppose an investor has a choice between buying this security or purchasing a different security that also costs $5,000 today, but pays off $5,500 with certainty in one year.How is an investor's choice of which security to purchase related to her degree of risk aversion?