(Expected rate of return and risk) Summerville Inc. is considering an investment
ID: 2823200 • Letter: #
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: E, 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 B is 1 %. (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.) O A. Stock A is better because it has a higher expected rate of return with less risk. O B. Stock B is better because it has a lower expected rate of return with more risk.Explanation / Answer
Answer a.
Stock A:
Expected Return = 0.20 * 12% + 0.60 * 16% + 0.20 * 20%
Expected Return = 16.00%
Stock B:
Expected Return = 0.20 * (-4%) + 0.30 * 5% + 0.30 * 15% + 0.20 * 22%
Expected Return = 9.60%
Answer b.
Stock A:
Variance = 0.20 * (0.12 - 0.16)^2 + 0.60 * (0.16 - 0.16)^2 + 0.20 * (0.20 - 0.16)^2
Variance = 0.00064
Standard Deviation = (0.00064)^(1/2)
Standard Deviation = 0.0253
Standard Deviation = 2.53%
Stock B:
Variance = 0.20 * (-0.04 - 0.096)^2 + 0.30 * (0.05 - 0.096)^2 + 0.30 * (0.15 - 0.096)^2 + 0.20 * (0.22 - 0.096)^2
Variance = 0.00828
Standard Deviation = (0.00828)^(1/2)
Standard Deviation = 0.0910
Standard Deviation = 9.10%
Answer c.
Answer a.
Stock A:
Expected Return = 0.20 * 12% + 0.60 * 16% + 0.20 * 20%
Expected Return = 16.00%
Stock B:
Expected Return = 0.20 * (-4%) + 0.30 * 5% + 0.30 * 15% + 0.20 * 22%
Expected Return = 9.60%
Answer b.
Stock A:
Variance = 0.20 * (0.12 - 0.16)^2 + 0.60 * (0.16 - 0.16)^2 + 0.20 * (0.20 - 0.16)^2
Variance = 0.00064
Standard Deviation = (0.00064)^(1/2)
Standard Deviation = 0.0253
Standard Deviation = 2.53%
Stock B:
Variance = 0.20 * (-0.04 - 0.096)^2 + 0.30 * (0.05 - 0.096)^2 + 0.30 * (0.15 - 0.096)^2 + 0.20 * (0.22 - 0.096)^2
Variance = 0.00828
Standard Deviation = (0.00828)^(1/2)
Standard Deviation = 0.0910
Standard Deviation = 9.10%
Answer c. The correct answer is A.
Stock A is better because it has higher expected rate of return with less risk.
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