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The expected rates of return for stocks A and B are 28% and 22% respectively. The...

  1. The expected rates of return for stocks A and B are 28% and 22% respectively. The T-bill rate is 12% and the expected rate of return on S&P 500 index is 24%. The standard deviation of stock A is 22% while that of B is 20%. If you could invest only in T-bills plus one of these stocks, which stock would you choose?

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Answer #1
Sharpe Ratio =(Rm - Rf) / SD of m
Sharpe Ratio of A =(Return on Portfolio A - Return on T-Bills) / Standard Deviation of Portfolio A
Sharpe Ratio of B =(Return on Portfolio B - Return on T-Bills) / Standard Deviation of Portfolio B
Sharpe Ratio of A =(28 - 12) / 22 =16% / 22% =0.7273
Sharpe Ratio of B =(22 - 12) / 20 =10% / 20% =0.50
Since Sharpe Ratio of Portfolio A is more than that of B hence the investment should be made in Portfolio A
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