Background: In the context of investing, probability models can assist with the

Question

Background: In the context of investing, probability models can assist with the evaluation of risk and expected return. Investors often consider both the expected return and risk when making investment choices. The mean of the distribution is the expected return. The standard deviation represents the risk. Business problem: Two stocks are available to invest. The return and associated probabilities for possible economic conditions are given in the following tables. Return from Brookside Corporation Economic Condition Recession Probability Function 03.1 | Return Y in % No growth 0.2 Slow growth 0.5 Boom 0.2 6 Based on these probability distribution, find the expected return and risk of each

Explanation / Answer

Expected Return = 0.1*(-2)++0.2*(0)+0.5*3+0.2*6 = 2.5%

Variance = 0.1*(-2)*(-2)+0.2*(0)*(0)+0.5*3*3+0.2*6*6-(2.5*2.5)

Variance = 5.85%

Risk = SQRT(5.85) = 2.42%

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