Question

You are trying to develop a strategy for investing in two different stocks. The anticipated annual return for a $1,000 investment in each stock under four different economic conditions has the following probability distribution.

		Returns
Probability	Economic Condition	Stock X	Stock Y
0.1	Recession	-50	-100
0.2	Slow Growth	20	50
0.45	Moderate Growth	100	130
0.25	Fast Growth	150	200

1. Expected Return for Stock X and Stock Y.
2. Standard Deviation for Stock X and Stock Y
3. Would you invest in Stock X or Stock Y? Explain.

Answer 1

Answer a & b:

For Stock X

Therefore, Expected Return for Stock X = 81.5

Standard Deviation for Stock X = 61.7475

For Stock Y

Therefore, Expected Return for Stock X = 108.5

Standard Deviation for Stock X = 85.6315

Answer c)

If the expected return for Stock X is greater than expected return for Stock Y, one should invest in Stock X.

However it should be noted that the standard deviation is higher in case of Stock X in comparison to Stock Y. So, if investor is looking for low risk then Stock Y should be selected.