Question 1 12 Marks] Stocks X and Y have the tollowng probablity distrbutions of

Question

Question 1 12 Marks] Stocks X and Y have the tollowng probablity distrbutions of expected future neturns -10% -35% 02 04 02 0 1 25 11 Calcula " the expected rate of ruturn, ty,tor Stock Y sexpected rate of return Stock X. 12 Caloulate the standand devaion of expected setuma, for Stock X (standard devabon for Stock 13 Under whuch crcumstances would most nvestors regard Stock Y as being less nsky than Stock rk. 12%) Y.20 35%) Now calodate the coencer, of vanabontor Slock Y X·gven the rtom at en above? Question 2 Adams Corporation has developed the folowing schedude of potential nvestment projects that may be undertaken dunng the next 6 monts 10 Marks) Cost (Misions of rands) Expected Rate of Return 300 20 14 00 10 12 00 21 IfAdams Corporation requres a mnmum rate of netum of 10 percent on all nvestments, which projecti's should be adopled? Explan 22 In general, how would a captal budgeting constrant on the avaable amount of investment tunds nluence those decisions (4 23 How would dffenng levels of project nsk influence these decisions? TURN OVER

Explanation / Answer

For stock X Prob(S) Ret(s) P(X) X X2 P.X2 2 P.X2-2 10% -10% -1.00% 1.00% 0.10% 20% 2% 0.40% 0.04% 0.01% 40% 12% 4.80% 1.44% 0.58% 20% 20% 4.00% 4.00% 0.80% 10% 38% 3.80% 14.44% 1.44% 12.00% Sum = 2.93% 1.44% 1.49% ST.dev ()= sqrt of above 12.20% For stock Y Prob(S) Ret(s) P(Y) Y Y2 P.Y2 2 P.Y2-2 10% -35% -3.50% 12.25% 1.23% 20% 0% 0.00% 0.00% 0.00% 40% 20% 8.00% 4.00% 1.60% 20% 25% 5.00% 6.25% 1.25% 10% 45% 4.50% 20.25% 2.03% 14.00% Sum = 6.10% 1.96% 4.14% ST.dev () = sqrt of above 20.35% CV = /m For Stock X CV = 12.20%/12% =           1.02 For Stock Y CV = 20.35%/14% =           1.45 If Stock Y is less highly correlated with the market than X, then it might have a lower beta than Stock X, and hence be less risky in a portfolio sense.

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