Question

The Allied Group has acquired Kramer Industries and is now considering additional investments. They have determined that there is a firm that is a good fit for their portfolio, the Kramer firm of Montana. The firm was established in 1990 and has the following historical returns: Kramer Industries Year Earnings 1990 (8% Loss) 1995 23% 2000 26% 2005 31% 2010 18% Address all of the following questions: What was the average return for the stock over the period of 1990 through 2010? What was the standard deviation for the stock over this period? Assume that you currently have a portfolio that returns 19.5%. If you add this stock to the current portfolio, what would happen to the average return on the portfolio? Should Allied invest in the stock? Justify your response.

Answer 1

Calculation of average and standard deviation is as follows :-

Years	Returns (x)	variance (x-avg. X)2
1990	-8%	676 (-8-18)2
1995	23%	25 (23-18)2
2000	26%	64 (26-18)2
2005	31%	169 (31-18)2
2010	18%	0 (18-18)2
	Avg. X = 90/5 = 18%	934

Standard deviation =√variance

=√934 = 30.56%

Since, we are currently able to get return of 19.5%, by investing in this stock which is yielding average return of 18%, our overall return will fall.

We should avoid to invest in this portfolio. There are two strong reasons for it :

1 . Since, it is giving a return which is less than the average return of our portfolio, thus it will reduce our portfolio return.

2. Most strong return is , it is having a standard deviation of about 30.56% which means stock can fluctuate by almost around 30.56%, which is quiet risky considering that the stock is giving return of only 18%.