Question

QUESTION 4

You are considering investing either of the three stocks- A, B and C. The following table provides the information regarding the stocks

	Returns (in percent)
Probability	Stock A	Stock B	Stock C
0.20	2	-3	5
0.50	10	8	8
?	15	20	12

Based on the above information

1. Calculate the expected rate of returns and variance for each of the three stocks?

                                                                                                              

2. Calculate the coefficient of variation for each security?                                   

c) Your friend suggests you to purchase Stock A because the stock provides the highest return as compared to other stocks. If you are a risk averse investor, which stock should you choose? Justify your answer.                                                                                          (1 mark)                                                                                                                       

Answer 1

a]

Expected return of portfolio E(r) =   p(s)*r(s),

where p(s) is the probability of each scenario,

and r(s) is the expected return of each scenario.

Variance of portfolio ²  = p(s)*[r(s) - E(r)]²

where [r(s) - E(r)]² is the squared deviation from the expected return.

Standard deviation =  variance

probability in third row = 1 - 0.2 - 0.5 = 0.3 (the total of the probabilities must equal 1)

b]

Coefficient of variation (CV) = standard deviation / expected return

c]

If you are a risk averse investor, you should choose Stock C because it has the lowest CV