Investments, tenth edition

Interest Rates

Probability

Year-End Bond Price

High

.2

$850

Unchanged

.5

 915

Low

.3

 985

 Your alternative investment is a T-bill that yields a sure rate of return of 5%. Calculate the HPR for each 

scenario, the expected rate of return, and the risk premium on your investment. What is the expected end-

of-year dollar value of your investment? 

 CONCEPT CHECK 

5.3 

   Time Series versus Scenario Analysis 

 In a forward-looking scenario analysis we determine a set of relevant scenarios and asso-

ciated investment rates of return, assign probabilities to each, and conclude by comput-

ing the risk premium (reward) and standard deviation (risk) of the proposed investment. 

In contrast, asset return histories come in the form of time series of realized returns that do 

not explicitly provide investors’ original assessments of the probabilities of those returns; 

we observe only dates and associated HPRs. We must infer from this limited data the prob-

ability distributions from which these returns might have been drawn or, at least, expected 

return and standard deviation.