Given the following information, which stock would you invest in A or B? There i

Question

Given the following information, which stock would you invest in A or B?

There is a 30% chance that demand will be strong for both A and B's products. If demand is strong, A’s return is 100% and B's return is 20%. If demand is normal, A's return is 15% and B's return is 15%. If demand is weak, A's return is -70% and B's return is 10%.

What is the expected return for both A and B? What is the standard deviation of both A and B? Given your return and risk results, which investment do you think is best?

Explanation / Answer

Expected return for bith A and B= .50(1+.20)+ .50(.15+.15) + .50(-.70+.10)

                                                   = .60+ .15- .30= .45 = 45 %                   ( assumed weight 50%)

expected return of A= .50*1.0+ .50+.15 + .50*(-.70) = -.225= 22.5%

expected return of B = .50*.20+ .50*.15+ .50*.10= 22.5%

standard deviation for both= .33 (100-22.5)*(20-22.5) + .33( 15- 22.5)*(15-22.5)+ .33( -70-22.5)*(10-22.5)

                                        = - 63.94 + 18.56 + 381.56 = 336.18 (assumed equal probability for each case)

stock B is better since there is no risk and returns are always positive.

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