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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

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
  1. a. Calculate the expected rate of return, r ^ Y , for Stock Y ( r ^ X = 12%).
  2. 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.

a.

Summary Introduction

To determine: The stocks expected rate of return.

Portfolio:

The portfolio refers to a group of financial assets like bonds, stocks, and equivalents of cash. The portfolio is held by investors and financial users. A portfolio is constructed in accordance with the risk tolerance and the objectives of the company.

Explanation

Solution:

The expected return on the stock:

The expected return on stock refers to the weighted average of expected returns on those assets, which are held in the portfolio.

Given,

Stock X

The expected rate of return for stock X is 12%.

Stock Y

The weights are 0.1, 0.2, 0.4, 0.2, and 0.1 for the given distribution.

The rate of return is (35%), 0%, 20%, 25% and 45% for the different demands.

Compute expected rate of return on the stock Y.

The formula to calculate the expected return is,

rY=i=1Nwiri=w1r1+w2r2+...+wNrN

Where,

  • rY is the expected rate of return for stock Y.
  • wi is the weight of the stock.
  • ri is the estimated rate of return.
  • N is the number of stocks.

Substitute 0.1, 0.2, 0.4, 0.2 and 0

b.

Summary Introduction

To determine: The standard deviation and coefficient of variation for stock Y and the possibility of stock Y being less risky than stock X.

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