Risk and Rates of Return Graded Assignment | Read Back to A Due Friday 12.22.17

Question

Risk and Rates of Return Graded Assignment | Read Back to A Due Friday 12.22.17 at 11:45 PM Attempts: Do No Harm: 1 1. Statistical measures of standalone risk As Aa Remember, the expected value of a probability distribution is a statistical measure of the average (mean) value expected to occur during all possible circumstances. To compute an asset's expected return under a range of possible circumstances (or states of nature), multiply the anticipated return expected to result during each state of nature by its probability of occurrence. Consider the following case: owns a two-stock portfolia that invests in Happy Dog Soap Company (HDS) and Black Sheep Broadcasting . Three-quarters of Jans alue consists of HDS's shares, and the balance consists of BSB's shares Escn stock's expected returm for the next yar will depend on forecasted market conditions. The expected returns n the stocks in different market conditions are detailed in the following t Market Condition Probability of Occurrence Happy Dog Soap 50% 25% 25% Strong Normal Weak 23% 14% -1896 slack Sheep Broadcasting 32% 8% -23% Calculate expected returns for the individual stocks in Juan's portfolio as well as the expected rate of return of the entire portfolio over the three possible market conditions next year. The expected rate of return on Happy Dog Soap's stock over the next year is expected rate of return on Black Sheep Broadcasting's stock over the next year is The expected rate of return on Juan's portfolio over the next year is . The . The expected returns for Juanr's portolio were calculated based on three possble conditions t the market. Sudh portfolio conditions wvary from time to time, and for each condition there will be a specific outcome outcomes can be represented in the form of a continuous probability distribution graph. probabilities and For example, the continuous probability distributions of rates of return on stocks for two different companies are shown on the following graph: PROBABILITY DENSITY

Explanation / Answer

a.

Expected return of Happy Dog = (50% × 23%) + (25% × 14%) + (25% × -18%)

= 11.50% + 3.50% - 4.50%

= 10.50%

Expected return of Happy Dog is 10.50%.

b.

Expected return of Black Sheep = (50% × 32%) + (25% × 18%) + (25% × -23%)

= 16.00% + 4.50% - 5.75%

= 14.75%

Expected return of Black Sheep is 14.70%.

c.

Expected return of portfolio = (75% × 10.50%) + (25% × 14.75%)

= 7.875% + 3.6875%

= 11.5625%

Expected return of portfolio is 11.5625%.

d.

Distribution of company B is wider than distribution of company A, so company B has more standard deviation that is risk.

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