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samualson samualson
wrote...
Posts: 2459
5 years ago
You are considering the three securities listed below.

Returns
ProbabilityStock AStock BStock C
20%2%-3%5%
50%10%8%8%
30%15%20%12%

a.Calculate the expected return for each security.
b.Calculate the standard deviation of returns for each security.
c.Compare Stock A with Stocks B and C. Is Stock A preferred over the others?
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Replies
wrote...
5 years ago
 
a.
RA = (.2)(2%) + (.5)(10%) + (.3)(15%) = 9.9%
RB = (.2)(-3%) + (.5)(8%) + (.3)(20%) = 9.4%
RC = (.2)(5%) + (.5)(8%) + (.3)(12%) = 8.6%

b.
Std.Dev.A = (2%-9.9%)2(.2) + (10%-9.9%)2(.5) + (15%-9.9%)2(.3) = 4.5%
Std.Dev.B = (-3%-9.4%)2(.2) + (8%-9.4%)2(.5) + (20%-9.4%)2(.3) = 8.1%
Std.Dev.C = (5%-8.6%)2(.2) + (8%-8.6%)2(.5) + (12%-8.6%)2(.3) = 2.5%

c.
Stock A dominates stock B because A has a higher expected return and a lower standard deviation. Stock A has a higher expected return than stock C, but also a higher standard deviation, so the choice between A and C depends on the level of risk aversion.
 
samualson Author
wrote...
5 years ago
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