question archive 11) Raz Mid Sdn
11) Raz Mid Sdn
Subject:FinancePrice:2.86 Bought20
11) Raz Mid Sdn. Bhd. is considering an investment in one of two common stocks. Given the following information that follows, which investment is better based on risk and standard deviation? Rate of return on Rate of return on Chance (probability of occurrence) Investment OB Investment IB 10 percent -10 percent 20 percent 5 percent 3 percent 12 percent 14 percent 8 percent 40 percent 15 percent 20 percent 25 percent 10percent 40 percent 7 percent 12. FM Corporation has prepared the following information regarding two investments under consideration. Calculate the expected rate of return and standard deviation. Which investment should be accepted? Common Stock A Common Stock B 0.20 -2 percent 0.10 4 percent 0.50 17 percent 0.30 0.30 6 percent 10 percent 26 percent 0.40 0.20 15 percent
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Solution 11-
| Probability (p) | Return OB (X) (%) | px | X-averageX | p*(X-averageX)2 |
| 0.1 | -10 | -1 | -25 | 62.5 |
| 0.2 | 5 | 1 | -10 | 20 |
| 0.4 | 15 | 6 | 0 | 0 |
| 0.2 | 25 | 5 | 10 | 20 |
| 0.1 | 40 | 4 | 25 | 62.5 |
| 15 | 165 |
Standard deviation= √165 = 12.85%
| Probability (p) | return (%) (y) | py | y-average y | p*(Y-averageY)2 |
| 0.1 | 3 | 0.3 | -7.6 | 5.776 |
| 0.2 | 12 | 2.4 | 1.4 | 0.392 |
| 0.4 | 14 | 5.6 | 3.4 | 4.624 |
| 0.2 | 8 | 1.6 | -2.6 | 1.352 |
| 0.1 | 7 | 0.7 | -3.6 | 1.296 |
| 10.6 | 13.44 |
Standard deviation = √13.44 = 3.67%
Based on the standard deviation as computed above, investment in IB is better because it has lower standard deviation (risk).
Solution (12)
| Probability (p) | Return (x) | px | X-averageX | p*(X-averageX)2 |
| 0.2 | -2 | -0.4 | -17.9 | 64.082 |
| 0.5 | 17 | 8.5 | 1.1 | 0.605 |
| 0.3 | 26 | 7.8 | 10.1 | 30.603 |
| 15.9 | 95.29 |
Expected return = 15.9%
Standard deviation = √95.29 = 9.76%
| Probability (p) | return (%) (Y) | py | Y-averageY | p*(Y-averageY)2 |
| 0.1 | 4 | 0.4 | -5.2 | 2.704 |
| 0.3 | 6 | 1.8 | -3.2 | 3.072 |
| 0.4 | 10 | 4 | 0.8 | 0.256 |
| 0.2 | 15 | 3 | 5.8 | 6.728 |
| 9.2 | 12.76 |
Expected return = 9.2%
Standard deviation =√12.76 = 3.57%
If we need to select the investment just on the basis of expected return then investment in stock A is preferable whereas investment in stock B is preferable if we need to take the decision on the basis of standard deviation.
We can select out of the given stocks on the basis of coefficient of variation. Coefficient of variation is equal to standard deviation as divided by expected return.
Therefore, coefficient of variation of stock A = 9.76/15.9 = 0.6138
Coefficient of variation of stock B = 3.57/9.2 = 0.39
Since coefficient of variation of stock B is less therefore it is preferred.
