EXPECTED RETURNS Stocks X and Y have the following probability distributions ofexpected future returns:Probability X Y0.1 (10%) (35%)0.2 2 00.4 12 200.2 20 2S0.1 38 45a. Calculate the expected rate of return, rˆY, for Stock Y ( rˆX= 12%).b. Calculate the standard deviation of expected returns, σX, for Stock X (σY =20.35%). Now calculate the coefficient of variation for Stock Y. Is it possible thatmost investors will regard Stock Y as being less risky than Stock X? Explain.
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.
EXPECTED RETURNS Stocks X and Y have the following probability distributions of
expected future returns:
Probability X Y
0.1 (10%) (35%)
0.2 2 0
0.4 12 20
0.2 20 2S
0.1 38 45
a. Calculate the expected
, for Stock Y ( rˆX
= 12%).
b. Calculate the standard deviation of expected returns, σX, for Stock X (σY =
20.35%). Now calculate the coefficient of variation for Stock Y. Is it possible that
most investors will regard Stock Y as being less risky than Stock X? Explain.
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