The yield from an investment in IT stocks on the Ghana Stock Exchange is expecte
ID: 3221932 • Letter: T
Question
The yield from an investment in IT stocks on the Ghana Stock Exchange is expected to be ‘High’, with a probability 0.25, ‘O.K’ with a probability of 0.5, or ‘Low’. According to market report by the Financial Times, each $1 invested in IT stocks on the Ghana Stock Exchange will yield a High return of 25%, an O.K return of 12%, or a Low return of -10% next year. Similarly, the yield from an investment in Insurance stocks on the Ghana Exchange is expected to be ‘High’, with a probability 0.4, ‘O.K’ with a probability of 0.5, or ‘Low’. According to market report, each $1 invested in Insurance stocks on the Ghana Stock Exchange will yield a High return of 10%, an O.K return of 8%, or a Low return of 12% next year. An investor has $100,000 to invest in either IT or Insurance stocks but not both. i. Which of the two stocks should be selected for investment based on total expected return? ii. Compute the coefficient of variation for each stock. iii. Which of the two stocks should be selected for investment based on your calculations in ii) above?
Explanation / Answer
Given,
IT Stocks
Probabilities
High probability=0.25
OK probability=0.5
Low probability=0.25(because total probability should be equal to 1)
Returns
High returns=25%
OK Returns=12%
Low returns=-10%
Insurance Stocks
Probabilities
High probability=0.4
OK probability=0.5
Low probability=0.1(because total probability should be equal to 1)
Returns
High returns=10%
OK Returns=8%
Low returns=2%(is it 2% or 12%)?
To calculate,
1) Expected Return(IT stocks)=(0.25*0.25+0.5*0.12+0.25*-0.1)
Expected Return(IT stocks)=0.0975
Expected Return(Insurance stocks)=(0.4*0.1+0.5*0.08+0.1*0.02)
Expected Return(Insurance stocks)=0.082
Hence we should select IT stock as it has more returns
2)Coefficient of Variation
IT Stocks
Standard Deviation=Sqrt{0.25*(0.25-0.0975)^2+0.50*(0.12-0.0975)^2+0.25*(-0.1-0.0975)^2}
solving we get
SD(IT stocks)=0.125773
Insurance Stocks
Standard Deviation=Sqrt{0.4*(0.1-0.082)^2+0.5*(0.08-0.082)^2+0.1*(0.02-0.082)^2}
solving, we get
SD(Insurance stocks)=0.287256
CoV(IT stocks)=SD/mean
CoV(IT stocks)=0.125773/0.0975
CoV(IT stocks)=1.29
CoV(Insurance Stocks)=0.287256/0.082
CoV(Insurance Stocks)=3.50
As coefficient of Variation for Insurance stocks is more its ideal to prefer IT stocks for Investment
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