Tutorial 3 – Risk & Return

1) You are considering a security with the following possible rates of return:
Probability Return (%)
0.15 9.5
0.25 13.6
0.50 14.9
0.10 25.3

a. Calculate the expected rate of return.

b. Calculate the standard deviation of the returns.

2) You are considering the three securities listed below.

Returns
Probability Stock A Stock B Stock 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 based on answer (a) and (b) only. Is Stock A
preferred over the others?

3) Suppose you are considering three investments for a period of one year. The outcomes are
uncertain but three different states of the economy have been ascertained. The relevant data
are given as follows:
State of economy Probability Investment’s Returns %
Project A Project B
Fast growth 0.15 25 30
Slow growth 0.60 15 10
Recession 0.20 -5 -10
Depression 0.05 -20 -5

a. Calculate the expected return for each project.

b. Calculate the standard deviation for each project.

c. Calculate the coefficient of variation for each project.

d. Compare the coefficient of variation calculated for each project in part c) and
decides which one project is to be chosen with valid explanation.
4) Bay View Incorporation has the following distribution of returns:

State Probability Return

Boom 0.3 0.25
Normal 0.4 0.15
Bust 0.3 0.30
Calculate the standard deviation of the returns.

5) Which of the following investments is clearly preferred an investor who is not holding a
well-diversified portfolio?
Investment Expected Return σ
A 18% 20%
B 20% 20%
C 20% 22%