(Expected rate of return and risk) Summerville Inc. is considering an investment

Question

(Expected rate of return and risk) Summerville Inc. is considering an investment in one of two common stocks. Given the information in the popup window:, which investment is better, based on the risk (as measured by the standard deviation) and return of each? a. The expected rate of return for Stock A is | %. (Round to two decimal places) The expected rate of return for Stock B is | %. (Round to two decimal places) b. The standard deviation for Stock A is %. (Round to two decimal places) The standard deviation for Stock Bis %. (Round to two decimal places) c. Based on the risk (as measured by the standard deviation) and return of each stock, which investment is better? (Select the best choice below.) ( A. O B. Stock A is better because it has a higher expected rate of return with less risk. Stock B is better because it has a lower expected rate of return with more risk.

Explanation / Answer

Expected Return of Stock A = 0.30 * 12% + 0.40 * 16% + 0.30 * 18%

Expected Return of Stock A = 3.6% + 6.4% + 5.4%

Expected Return of Stock A = 15.4%

Standard Deviation of Stock A2 = 0.30 * (12% - 15.4%)2 + 0.40 * (16% - 15.4%)2 + 0.30 * (18% - 15.4%)2

Standard Deviation of Stock A = 2.37%

Expected Return of Stock B = 0.15 * (-4%) + 0.35 * 7% + 0.35 * 14% + 0.15 * 22%

Expected Return of Stock B = -0.60% + 2.45% + 4.90% + 3.30%

Expected Return of Stock B = 10.05%

Standard Deviation of Stock B2 = 0.15 * (-4% - 10.05%)2 + 0.35 * (7% - 10.05%)2 + 0.35 * (14% - 10.05%)2 + 0.15 * (22% - 10.05%)2

Standard Deviation of Stock B = 7.73%

We will choose Stock A as it has better return with less risk

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