1. Given the following probability distribution and stock return information: Ec
ID: 2767817 • Letter: 1
Question
1. Given the following probability distribution and stock return information:
Economy State
Probability (p)
Stock A Return
Stock B Return
Good
0.3
15%
10%
Normal
0.6
5%
8%
Bad
0.1
-3%
-20%
A) Calculate expected return rates E(r) for stock A and stock B;
B) Calculate standard deviations for stock A and stock B;
C) Calculate the coefficients of variation for stock A and stock B;
D) If risk free rate is 2%, calculate the Sharpe Ratios for stock A and stock B.
E) What stock is a better investment opportunity?
2. If you have $10,000 to invest and you put $4,000 in stock A and $6,000 in stock B (the two stocks listed in Question 1), then what is the expected return rate of your portfolio (entire investment of $10,000)?.
3. The risk free rate is 2%. The expected return rate of the market portfolio is 8%. If stock C has a beta 1.5 and stock D has a beta 0.8, what are the expected return rates of stock C and stock D?
Economy State
Probability (p)
Stock A Return
Stock B Return
Good
0.3
15%
10%
Normal
0.6
5%
8%
Bad
0.1
-3%
-20%
Explanation / Answer
1.A)
expected return rates E(r) for stock A=15%*0.3+0.6*5%-0.1*3%=7.2%
expected return rates E(r) for stock B=10%*0.3+0.6*8%-0.1*20%=5.8%
2.
the expected return rate of your portfolio=$4,000*7.2%+$6,000*5.8%=$636
3.
the expected return rates of stock C=2%+1.5(8%-2%)=2%+9%=11%
the expected return rates of stock C=2%+0.8(8%-2%)=2%+4.8%=6.8%
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