In: Finance
Probability |
Future Return - X |
Future Return - Y |
.1 |
-10% |
-35% |
.2 |
2% |
0% |
.4 |
12% |
20% |
.2 |
20% |
25% |
.1 |
38% |
45% |
(A) Computation of RY
Yi (A) |
Probability (p) (B) |
RY (A)*(B) |
(35) | 0.1 | (3.5) |
- | 0.2 | - |
20 | 0.4 | 8.0 |
25 | 0.2 | 5.0 |
45 | 0.1 | 4.5 |
Total RY | 14.0 |
Hence, RY = 14%
(B) Computation of standard deviation of X
Xi | RX | (Xi - RX) |
(Xi - RX)^2 (A) |
Probability (p) (B) |
(Xi - RX)^2 * p (A) *(B) |
(10) | 12 | (22) | 484 | 0.1 | 48.4 |
2 | 12 | (10) | 100 | 0.2 | 20 |
12 | 12 | - | 0 | 0.4 | 0 |
20 | 12 | 8 | 64 | 0.2 | 12.8 |
38 | 12 | 26 | 676 | 0.1 | 67.6 |
148.8 |
Standard deviation (S.D.) of X = Square root of 148.8
= 12.20%
Coefficent variation of X = (S.D. of X / RX)
= (12.2 / 12)
= 1.016
Coefficent variation of Y = (S.D. of Y / RY)
= (20.35 / 14)
= 1.453
Lower the Standard deviation and Coefficent of variation, better the risk-return trade-off. Since the standard deviation and coefficient variation of Y is higher as compared to X, hence Y is more risky per dollar of return.