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Determining risk between two investment options

1. An individual has to choose between investment A and investment B. The individual estimates that the income and probability of the income from each investment are as given in the following table:

....Investment A..............................Investment B
Income.....Probability................Income.........Probability
$4000...........0.2........................$4000..............0.3
$5000...........0.3........................$6000..............0.4
$6000...........0.3........................$8000..............0.3
$7000...........0.2

a) Using excel statistical tool, calculate the standard deviation of the distribution of each investment.
b) Which of the two investments is more risky?
c) Which investment should the individual choose?

Solution Preview

Dear Student:

Please open the attached Excel file and see the explanations below:

The expected income for the investor is calculated multiplying each income by its probability and then summing up.

Expected income for investment A = $5,500
Expected income for investment B = $6,000

Standard deviation is calculated ...

Solution Summary

This solution compares two investments A and B, which have different probabilities to produce a certain level of income. Using Excel, the solution shows how to compute the expected return an the standard deviation of each investment, and then compares the two investment options for riskiness. The solution also discusses how investors can determine which investment option to choose, depending on the investors' preferences and risk tolerance.

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