Question

Question 1:

You earn 15% in year 1, 25% in year 2 and 20% in year 3, what is your 3-year net return?

Question 2:

how to rank the following investments

Investment 1: return--10%   variance--5%

Investment 2: return--20%   variance--15%

Investment 3: return--12%   variance—20%

Risk-free rate: 5% (by assumption)

Reminder: convert variance to standard deviation first

Answer 1

Question 1. Calculation of 3 year net return:

Return means expected return or mean return or average return.

Therefore,

Expected return (simple average) for 3 years (15%+25%+20%)/3 = 20%

Expected return (weighted average give more weight in lates year and less weight in oldest year):

Expected retrun(Weighted Average) = [(1*15%)+(2*25%)+(3*20)]/(1+2+3) = 20.83%

Question 2. Ranking the investment:

Conversion of variance into standard deviation

Investment 1 = Variance 5% into Standard deviation = 2.236

Investment 2  = Variance 15% into Standard deviation = 3.873

Investment 3 = Variance 5% into Standard deviation = 4.472

Risk return analysis:

Investment	Return	Standard Deviation	Rank	Analysis
1	10%	2.236	III	Lower return and lower risk compared to investment 2 and 3
2	20%	3.873	I	Higher return but lower risk than investment 3
3	12%	4.472	II	Higher return and higher risk than invesstment 1