Suppose you are considering an investment in one of two stocks, A or B. The fore

Question

Suppose you are considering an investment in one of two stocks, A or B. The forecast for whether or not the value of each stock will increase or decrease is shown in the tables below. Each table shows the probability distribution for the percent change in value of the stock.

STOCK A STOCK B

(% change in value a) P(A) (%change in value b) P(b)

-0.10 0.20 -0.15 0.20

0.05 0.60 0.05 0.60

0.10 0.20 0.15 0.20

a) [4] Find the expected % change in value of each stock, E(A) and E(B), and compare. b) [8] Find the standard deviation for each. c) [2] From the results of part (b), which stock shows more variation in the percent change of value, and so, would be considered riskier?

Explanation / Answer

a) E(A) :

E(A) = 0.03

For E(B):

E(B) = 0.03

b)

Var(Stock A) = 0.0055 - 0.032 = 0.0046

Var(Stock B) = 0.0105 - 0.032 = 0.0096

c) Stock B is more higer than that stocak 2 since its variance is high

Stock A (Xi) P(A) = pi xipi xi^2 pi -0.1 0.2 -0.02 0.002 0.05 0.6 0.03 0.0015 0.1 0.2 0.02 0.002 Total: 0.03 0.0055

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