Question

(Expected rate of return and risk) Syntex, Inc. is considering an investment in one of two common stocks. Given the information that follows, which investment is better, based on the risk (as measured by the standard deviation) and return? Common Stock A Common Stock B Probability Return Probability Return 10% 0.35 0.25 -4% 14% 7% 0.30 0.25 16% 0.35 20% 0.25 23% 0.25 %. (Round to two decimal places.) a. Given the information in the table, the expected rate of return for stock A is %. (Round to two decimal places.) The standard deviation of stock A is %. (Round to two decimal places.) b. The expected rate of return for stock B is The standard deviation for stock B is %. (Round to two decimal places.) c. Based on the risk (as measured by the standard deviation) and return of each stock, which investment is better? (Select the best choice below.) A. Stock A is better because it has a higher expected rate of return with less risk. B. Stock B is better because it has a lower expected rate of return with more risk.

Answer 1

Calculate the expected return as follows:

Α ou wn B C D E F Stock A Stock B Probability Return Weighted Deviations Probability Return Weighted return Deviations 0.35 10% 0.035 0.000773 0.25 -4% -0.01 0.00525625 0.3 14% 0.042 0.000015 0.25 7% 0.0175 0.00030625 0.35 20% 0.07 0.000983 0.25 16% 0.04 0.00075625 0.25 23% 0.0575 0.00390625 Expected return Stock A 14.70% Standard deviation A 4.21% Expected return Stock B 10.50% Standard deviation B 10.11% Stock A is better, higher expected return with less return 7 a 8 9b 10 11 C

Formulas:

B D E A 1 2 3 4 5 6 7 а Probability Return 0.35 0.1 0.3 0.14 0.35 0.2 F G Stock A Weighted return Deviations Probability Return =B3*C3 =B3*(C3-$D$7)^2 0.25 -0.04 =B4*C4 =B4*(C4-$D$7)^2 0.25 0.07 =B5*C5 =B5*(C5-$D$7)^2 0.25 0.16 0.25 0.23 =SUM(D3:05) =SUM(E3:E5)^(1/2) Expected return Stock B Standard deviation B Stock A is better, higher expected return with less return Η Stock B Weighted return Deviations =F3*G3 =F3* (G3-$H$9)^2 =F4*G4 =F4* (G4-$H$9)^2 =F5*G5 =F5*(G5-$H$9)^2 =F6*G6 =F6*(G6-$H$9)^2 Expected return Stock A Standard deviation A =SUM(H3:H6) 9b 10 11 C =SUM(13:16)^(1/2)