Summerville is considering an investment in one of two common stocks. Given the

Question

Summerville is considering an investment in one of two common stocks. Given the information in the table below, which investment is better based on the risk (as measured by the standard deviation) and return of each?

COMMON STOCK A COMMON STOCK B

PROFITABILITY RETURN PROFITABILITY RETURN

0.20 12% 0.15 -6%

0.60 15% 0.35 5%

0.20 20% 0.35 15%

0.15 22%

a. The expected rate of return for stock A is.......% (Round to two decimal places)

The expected rate of return for stock B is......% (Round to two decimal places)

b. The standard deviation for stock A is............% (Round to two decimal places)

The standard deviation for stock B is..........% (Round to two decimal places)

c. Based on the risk (as measured by the standard deviation) and return of each stock, which investment is better? Select the best choice below

A. Stock A is better because it has a higher expected rate of return with less risk

B. Stock B is better because it has a lower expected rate of return with more risk

Explanation / Answer

a.

Expected return of A = 15.40%

Standard deviation of A = 2.58%

Expected return of B = 9.40%

Standard dev of B = 8.78%

So stock A is better

p(x) return p*x p*(x - mean)^2 0.2 12.00% 0.024 0.000231 0.6 15.00% 0.09 0.000010 0.2 20.00% 0.04 0.000423

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