A close family friend has approached you to help her determine which of the two common stocks she should invest in. Common Stock A Common Stock B Probability Return Probability Return 0.3 11% 0.2 -5% 0.4 15% 0.3 6% 0.3 19% 0.3 14% 0.2 22% Required: a) Calculate the expected returns of stock A b) Determine the risk (standard deviation) and return of stock A c) Calculate the expected returns of stock B d) Determine the risk (standard deviation) and return of stock B e) Which investment should your friend invest in?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
A close family friend has approached you to help her determine which of the two common stocks
she should invest in.
Common Stock A Common Stock B
Probability Return Probability Return
0.3 11% 0.2 -5%
0.4 15% 0.3 6%
0.3 19% 0.3 14%
0.2 22%
Required:
a) Calculate the expected returns of stock A
b) Determine the risk (standard deviation) and return of stock A
c) Calculate the expected returns of stock B
d) Determine the risk (standard deviation) and return of stock B
e) Which investment should your friend invest in?
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