Risk and Rates of Return: Stand-Alone Risk Stand-alone risk is the risk an inves
ID: 2785251 • Letter: R
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Risk and Rates of Return: Stand-Alone Risk
Stand-alone risk is the risk an investor would face if he or she held only -Select-one portfolioone assetmultiple assetsCorrect 1 of Item 1. No investment should be undertaken unless its expected rate of return is high enough to compensate for its perceived -Select-riskcostreturnCorrect 2 of Item 1. The expected rate of return is the return expected to be realized from an investment; it is calculated as the -Select-combined sumstandard deviationweighted averageCorrect 3 of Item 1 of the probability distribution of possible results as shown below:
The -Select-widertighterbroaderCorrect 4 of Item 1 an asset's probability distribution, the lower its risk.
The coefficient of variation is a better measure of stand-alone risk than standard deviation because it is a standardized measure of risk per unit; it is calculated as the -Select-correlation coefficientrisk premiumstandard deviationCorrect 5 of Item 1 divided by the expected return. The coefficient of variation shows the risk per unit of return, so it provides a more meaningful risk measure when the expected returns on two alternatives are not -Select-identicaldifferentcorrelatedCorrect 6 of Item 1.
Quantitative Problem: You are given the following probability distribution for CHC Enterprises:
What is the stock's expected return? Round your answer to 2 decimal places. Do not round intermediate calculations.
%
What is the stock's standard deviation? Round your answer to two decimal places. Do not round intermediate calculations.
%
What is the stock's coefficient of variation? Round your answer to two decimal places. Do not round intermediate calculations.
State of Economy Probability Rate of return Strong 0.25 20% Normal 0.45 8% Weak 0.3 -4%Explanation / Answer
Expected return=0.25*20%+0.45*8%+0.3*(-4%)=7.4%
Standard deviation=sqrt(0.25*(20-7.4)^2+0.45*(8-7.4)^2+0.3*(-4-7.4)^2)=8.87919%
Coefficient of variation=Standard devaition/mean*100%=8.87919/7.4*100%=119.9891%
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