Question

Two stocks under evaluation have the following probability distribution for their rate of returns. Probability 30% 20% 50% Rate of Return Stock A Stock B 18% 10% -2% 5% 10% 0% Table Q1 (a) Explain the expected return for each of the stocks by giving the value. (3 marks) (b) Explain the standard deviation for the return of each of the stocks by giving the value. (6 marks) (c) Explain the correlation coefficient between the returns of the two stocks by giving the value (5 marks) (d) You have certain amount of fund to invest on only one of the two stocks and the risk-free asset at rate 3 % and expect 8 % of the return of the portfolio. Which portfolio do you prefer, portfolio A consisting of Stock A and the risk-free asset or portfolio B consisting of Stock B and the risk-free asset? (Assume that borrowing of the risk-free asset is allowed.) (6 marks)

Answer 1

PXP I PA Α- ΣΡΑ P(A-EPA) 2 Prob 3.6 12.4 30.952 .5 -2 -1 -3.6 6.48 4.4 5.808 43.04 5.6 A PXA= Ã A-A P(A-A2 19.2 5.4 2 -2 -Y - 2018 n4 Stock B - PAB zB T & PAB2B B-B P(B-1B) 2 3. 12 2 oń Jo 5 0 3 1 0 6 I 1018 2 Expected Return of A = 10 B = 4 duration of a= [48= 6.93 B = V1 = 3.32 Standard

Correlation Coefficient - Lovariante covariance is = Prob ( AA) (B-B) 0x 14.4 -12 correlations & 12 Iw 6.93x3 32 23 he 24 B = Covariance 12 .25 = variance 48 il Bo - 12 1:09 from the given data. A = 3 t. 25 (8-3) = 4.25 B = 3+1,09(8-3) = 8.45 Conclusion: - much Patfolio B is better because it Eupected return than potfolio A. gives