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You meet a friend who is planning to invest in stocks. They say that “The expected...

You meet a friend who is planning to invest in stocks. They say that

“The expected return on Microsoft is 7% and the volatility of returns is 24. Whereas for Wal-Mart the expected return is just 6% and the volatility of returns is 30.

So, it never makes sense to own Wal-Mart stock as Microsoft stock strictly dominates Wal-Mart stock.”

Is your friend correct? Explain why.

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Answer #1

This can evaluated by calcualting the Return voer Risk Ratio.

Return - Risk Ratio = Return / Standard Deviation

Return - Risk Ratio of Microsoft = 7% / 24%

= 0.29167

Return - Risk Ratio of Wal-Mart= 6% / 30%

= 0.20

The Return per unit of Risk is more in Stock of Microsoft. My friend is right.

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