Question

# Following details are available about stock A: 15% chance that the return of the stock will...

Following details are available about stock A: 15% chance that the return of the stock will be 10%, 35% chance that the return of the stock will be 11.5%, 20% chance that the return of the stock will be 14% and 30% chance that the return of the stock will be 12.5%.

Calculate the average return and risk of the stock and interpret your answer.

Expected return of stock A = Sum of ((Probability of a scenario x Expected return in that scenario)) = (15% * 10%) + (35% * 11.5%) + (20% * 14%) + (30% * 12.5%) = 1.5% + 4.0% + 2.8% + 3.8% = 12.1%

Standard deviation (risk) of stock A = Square root of investment variance of stock A, where

Investment variance = Sum of (Probability of a scenario x Square of (Expected return in that scenario - Expected return of stock A))

Hence, standard deviation = Square root of ((15% * ((10% - 12.1%)^2)) + (35% * ((11.5% - 12.1%)^2)) + (20% * ((14% - 12.1%)^2)) + (30% * ((12.5% - 12.1%)^2))) = 1.25%

The low standard deviation number implies that stock A is a low volatility / risk stock.

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