Consider the rate of return of stocks ABC and XYZ. a. Calculate the arithmetic a

Question

Consider the rate of return of stocks ABC and XYZ.

a. Calculate the arithmetic average return on these stocks over the sample period.

b. Which stock has greater dispersion around the mean return?

ABC

XYZ

c. Calculate the geometric average returns of each stock. What do you conclude? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

d. If you were equally likely to earn a return of 22%, 12%, 14%, 7%, or 1%, in each year (these are the five annual returns for stock ABC), what would be your expected rate of return? (Do not round intermediate calculations.)

e. What if the five possible outcomes were those of stock XYZ?

f. Given your answers to (d) and (e), which measure of average return, arithmetic or geometric, appears more useful for predicting future performance?

Arithmetic

Geometric

Year rABC rXYZ 1 22 % 34 % 2 12 12 3 14 18 4 7 0 5 1 8

Explanation / Answer

c. geometric average of ABC = 10.98%

geometric averae of xyz = 10.26%

d. expected return = (22 + 12 + 14+ 7 + 1)/5 = 11.20%

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22 34 12 12 14 18 7 0 1 -8 average 11.20 11.20 dispersion 7.03 14.57

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