According to Carlo’s stock broker, Investment A has relatively
high historical rates of return, and so he is recommending the
purchase of Investment A. Carlo’s insurance advisor, on the other
hand, is recommending the purchase of Investment B based on its
historical rates of return. And still another advisor is
recommending the purchase of a third investment (Investment C)
based on its historical returns. Carlo is trying to determine which
of the three investments is best, and he is focusing his decision
making process on the concepts of risk and return.
[Note: This assignment is four pages long. You can either use
this document for your submission or you can create your own Excel
spreadsheet. Since there are many calculations on this assignment,
it is recommended that you use Excel to organize your
calculations.]
Investment A is an equity (stock) investment in an American
company. Returns on this Investment for the past 6 years are
detailed in the table below, and Carlo expects the returns of the
next 6 years to be the same as the last 6 years.
Year
Return
1
+80%
2
-50%
3
+70%
4
-50%
5
+40%
6
-5%
5. What is the relevant annual rate of return per unit of risk
(expressed as one number) for Investment A over the 6-year period?
_____________
Investment B is represented by the cash value of a whole life
insurance policy. Returns on this Investment for the past 6 years
are detailed in the table below, and Carlo expects the returns of
the next 6 years to be the same as the last 6 years.
Year
Return
1
+4.9%
2
+5.0%
3
+4.6%
4
+5.1%
5
+4.9%
6
+4.8%
6. With respect to Investment B, if the annual returns are
each considered to be equally likely to occur, calculate the
standard deviation of the returns. ____________
7. What is the expected average annual rate of return on
Investment B? ___________
8. An investor who invested $10,000 in Investment B at the
beginning of year 1 would have how much in the investment at the
end of year 6? ______________