# 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.

#### Solution Summary

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.