Question

Use the data shown below to answer the questions in the spaces provided: WEIGHTS 0.50 0.50 Year Market Bake Date HomeChef PORTFOLIO 0.37 0.26 0.47 0.30 -0.54 -0.20 0.15 0.07 0.00 0.15 0.07 -0.14 0.18 -0.04 -0.15 -0.22 4 -0.13 -0.28 0.02 -0.14 0.11 0.40 0.10 -0.18 6 0.30 0.17 -0.23 0.26 -0.10 0.42 7 0.04 0.30 8 -0.18 -0.04 -0.32 -0.03 0.52 0.75 0.28 0.38 10 0.0780 0.0920 0.0640 0.0800 0.2295 avg stdev 0.3660 0.2390 0.1908 2.9429 3.978 3.734 2.386 CV 4. How were the 'avg' values calculated? Briefly describe how this calculation differed from the calculation of the expected returns for the T Bonds shown earlier. 5. Based just on average returns, which of the three (Market, HomeChef, BakeDate) offers the highest return? Which of the three has the highest risk? 6. Which tool or measurement would be used to make the choice amongst the three assets? 7.

Answer 1

1. How the Average Values were Calculated ?

Average values were calculated using simple formula i.e. Sum of Returns in different years / no. of years..

for example, let's pick Market returns. Sum of return in all 10 years = .80 or say 80%. now divide it by no. of years i.e. 10 = .08 or say 8% p.a.

How it differs from expected retun from T Bonds -

in case of Bonds we know the present as well as future cashflows, so we calculate our expected return using principles of Internal Rate of Return.

whearas in Equity future returns are based on How company performs. We do not have any certainty regards to future cashflow so we use historical data to assess the Expected return.

2. Highest Return - based on average return

Average return of Market = .08 or 8%

Average return of Homechef = .064 or 6.40 %

Average return of BakeDate = .0920 or 9.20 %

you can clearly see BakeDate stock provides Highest Return.

3. Highest Risk

Standard Deviation of Market = 0.1908 or 19.08%

SD of HomeChef = 0.2390 or 23.90 %

SD of BakeDate = 0.3660 or 36.60%

Standard deviation tells us about the degree of variation from the average return. Lower Deviation shows there is less variation or say more consistency in year to year returns whearas Higher Deviation shows High Variation or Less Consistency in return.

So the most risky is Stock of BakeDate

4. Tool for Best Decision

CV is the Best tool. we can calculate it using SD / Mean return. it shows risk for 1% of return.

In case where stock has different returns but risk is same for all. we can easily select stock which has highest return as risk is same in all cases.

but generally stock has Different returns as well as different risk (SD). So we use CV which compares Risk in different stock for 1% return.

So which stock has lowest CV is best.