2. You are interested in buying a stock that has a price of $72. You have projec

Question

2. You are interested in buying a stock that has a price of $72. You have projected that next year there is: a 10% probability the stock will equal $1, a 20% probability the stock will equal $44, a 30% probability the stock will equal $83, a 30% probability the stock will equal $95, and a 10% probability the stock will equal $150. Answer the following (showing all work):

(a) what is the expected return on the stock if you buy today and sell next year?

(b) what is the expected standard deviation of the stock?

Explanation / Answer

(a) what is the expected return on the stock if you buy today and sell next year?

Expected Value of stock price next year = $ 77.30

Expected return on the stock = (Expected Value of stock price next year - Purchase Price)/Purchase price

Expected return on the stock = (77.30-72)/72

Expected return on the stock = 7.36%

(b) what is the expected standard deviation of the stock?

Expected standard deviation of the stock = (1436.21)^(1/2)

Expected standard deviation of the stock = $ 37.90

Working

Probability Stock Price Prob * Stock Price (Expected Value - Stock Price)^2 * Prob 10% 1 0.10 582.169 20% 44 8.80 221.778 30% 83 24.90 9.747 30% 95 28.50 93.987 10% 150 15.00 528.529 Expected Value 77.30 1436.21

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