Probability

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
icon
Related questions
Question

You have inherited some funds and decided to invest in one of two international companies – Coca Cola and Walmart.  You research revealed and found the following possible performance of the investments.

  • You have estimated the following probability distributions of expected future returns

for Coca Cola and Walmart.

 

Coca Cola                              Walmart

Probability     Return           Probability     Return

0.1                   –10%               0.2                   2%

0.2                   10                    0.2                   7

0.4                   15                    0.3                   12

0.2                   20                    0.2                   15

  • 40                    1                   16

 

  • What is the expected rate of return for Coca Cola and Walmart?

 

   Calculation of Expected rate of return for Coca Cola and Walmart

 

Coca Cola     

 

Walmart

Probability   (A)     

Return   (B)

A*B

Probability   (C)     

Return   (D)

C*D

0.1                          

-10

-1

0.2                          

2

0.4

0.2                          

10                           

2

0.2                          

7

1.4

0.4                          

15

6

0.3                          

12

3.6

0.2                          

20

4

0.2                          

15

3

0.1                          

40

4

0.1                          

16

1.6

 

Total 

15

 

Total 

10

So from above calculation we can see that expected rate of return for Coca Cola is 15%  & for Walmart is 10%

 

 

  • What is the standard deviation of expected returns for Stock X and for stock Y?

 

  Calculation of standard deviation of Stock X 

 

Stock X

Given Return   (A)

Expected Return (B)

A-B

(A-B)2

Probability  

Probability * (A-B)2

-10

15

-25

625

0.1

62.5

10                           

15

-5

25

0.2

5

15

15

0

0

0.4

0

20

15

5

25

0.2

5

40

15

25

625

0.1

62.5

 

Total 

0

 

1

135

             

 Standard devaiation =    √Σ probability *(A-B)2

                                   =  √ 135

                              = 11.6189  

 

Calcualtion of Standard Deviation of Stock Y

Stock Y

Given Return   (C)

Expected Return (D)

C-D

(C-D)2

Probability  

Probability * (C-D)2

2

10

-8

64

0.2

12.8

7

10

-5

25

0.2

5

12

10

2

4

0.3

1.2

15

10

5

25

0.2

5

16

10

6

36

0.1

3.6

 

Total 

0

 

1

27.6

 

                Standard Deviation = √Σ probability *(C-D)2

                                                =√27.6

                                                =5.2535

 

 

 

  • Which stock is riskier and why?

                                                                                               

 Calculation of Stock Risk

  Stock X =  Standard Deviation /Expected Return

           =11.6189/15  

                 =0.7745

 

  Stock Y  = 5.2535/10

                =0.5253

 

From the above calculation we can say that Stock Y is less risker than to Stock X as it's Coefficient of Variation(CV) is lower than Stock X. CV is the measure of calculation of risk.

 

 

 

(b) You received $2,000,000 and decided to invest $1,200,000 in Coca Cola        stocks and $800,000 in stock Walmart. If  the correlation of returns               between Coca Cola and Walmart is 0.5, compute the following:

 

  • The expected return from the portfolio (Please answer this) 
  • The standard deviation of returns from the portfolio (Please answer this)                                     
Expert Solution
steps

Step by step

Solved in 3 steps with 4 images

Blurred answer
Knowledge Booster
Stock Market Analysis
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.
Similar questions
Recommended textbooks for you
Essentials Of Investments
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
FUNDAMENTALS OF CORPORATE FINANCE
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:
9781260013962
Author:
BREALEY
Publisher:
RENT MCG
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
Foundations Of Finance
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education