1. An individual has to choose between investment A and investment B. The indivi

Question

1. An individual has to choose between investment A and investment B. The individual estimates that the income and probability of the income from each investment are as given in the following table: (a) Using Excel’s statistical tools, calculate the standard deviation of the distribution of each investment. (b) Which of the two investments is more risky? (c) Which investment should the individual choose?

Income Probability
4000 0.2
5000 0.3
6000 0.3
7000 0.2

Investment B
Income Probability
4000 0.3
6000 0.4
8000 0.3

Explanation / Answer

a) The standard deviation of each investment is:-

b) Investment B is more risk as standard deviation for B is more.

c) return per unit risk for A = 1375/1565.497 = 0.878

return per unit risk for B = 2000/2394.438 = 0.835

Return per unit ridk for A is greater than investment B. So investment B should be chosen

Investment A Investment B Income Probability xf Income Probability $4,000 0.2 $800 3200000 $4,000 0.3 $1,200 4800000 $5,000 0.3 $1,500 7500000 $6,000 0.4 $2,400 14400000 $6,000 0.3 $1,800 10800000 $8,000 0.3 $2,400 19200000 $7,000 0.2 $1,400 9800000 Â Â $1,375 7825000 $2,000 12800000 standard deviation of A 1565.497 standard deviation B 2394.438 .

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