Expected rate of return and standard deviation of return
1. Stocks X and Y have the following probability distributions of expected future returns:
PROBABILITY X Y Rate of return Y Rate of return X
10% -10% -35% -4% -1%
20% 20% 0% 0% 4%
40% 12% 20% 8% 5%
20% 20% 25% 5% 4%
10% 38% 45% 5% 4%
a. Calculate the expected rate of return, khat, for Stock Y (expected return for Stock X, Kx hat, equals 12%).
b. Calculate the standard deviation of expected returns for Stock X. (that for Stock Y is 20.35%). Now Calculate the
coefficient of variation for Stock Y. Is it possible that most investors might regard Stock Y as being less risky than
Stock X? Explain.
2. Shalit Corporation's 2002 sales were $12 million. Sales were $6 million 5 years earlier (in 1997).
a. To the nearest percentage point, at what rate have sales been growing?
b. Suppose someone calculated the sales growth for Shalit Corporation in part a as follows:
"Sales doubled in 5 years. This represents a growth of 100 percent in 5 years, so dividing 100 percent by 5, we find the growth rate
to be 20 percent per year". Explain what is wrong with this calculation.
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The solutions shows steps to calculate the expected rate of return and standard deviation of expected returns of stocks when the probability distribution of expected return are given.
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Active since 2003