Question

Suppose you are holding stock A and there are three possible outcomes. Outcome 1 happens with 20% probability and -20% return. Outcome 2 happens with 40% probability and 20 return. Outcome 3 happens with 40% probability and 50% return. What is the Sharpe Ratio of stock A?

		0.931
		1.473
		0.246
		0.325

Answer 1

Expected return of stock E= sum of (probability*return)

=.2*-20+.4*20+.4*50 =24

Variance= sum of(probability*(E-return)^2)

=.2*(-20-24)^2+.4*(20-24)^2+.4*(50-24)^2 =664

standard deviation=sqrt(variance)= 25.77

Sharpe ratio= (Expected return-risk free rate)/std dev = (24-0)/25.77 =.931 (option A)

note: risk free rate is taken as zero since not given