Consider two stocks whose one-year returns over the past decade were as follows:

Question

Consider two stocks whose one-year returns over the past decade were as follows: X: 5%, 15%, -20%, 25%, 10%, 25%, -10%, 10%, 15%, 25% Y: 8%, 8%, 8%, 8%, 10%, 6%, 8%, 8%, 8%, 8% a. Calculate the average yearly return for stock X. Do the same for stock Y. b. Calculate the standard deviation of stock X’s yearly returns. Do the same for stock Y. c. Which of these stocks would you rather own, and why? d. Someone else might prefer the other stock. Would that person be more risk-averse than you, or less?

Explanation / Answer

(a) The average yearly return for Stock X is 10%.
The average yearly return for Stock Y is 8%.

(b) Standard deviation of Stock X's yearly returns = 15.092%.
Standard deviation of Stock Y's yearly returns = 0.943%.

(c) I would rather own Stock Y, because it has very low standard deviation.
In this context, low standard deviation means that the volality or the variability in the yearly returns of Stock Y is quite low. Hence, the yearly returns are more predictable compared to the other stock. It is less risky to thus invest in Stock Y.

(d) That person would be less risk-averse than me because he is investing in a stock whose yearly returns have high variability. Hence, it is more risky to invest in this kind of a stock.

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