Question

# A security had the following returns over the last four years. Compute the standard deviation of...

A security had the following returns over the last four years. Compute the standard deviation of these historical returns.

 Return (%) 19 5 17 -5

11.10%

11.00%

10.90%

11.20%

10.80%

A security had the following returns over the last four years. Compute the geometric mean return.

 Return (%) 2 15 2 7

6.27%

5.97%

6.17%

6.37%

6.07%

 You have been scouring The Wall Street Journal looking for stocks that are “good values” and have calculated expected returns for five stocks. Assume the risk-free rate (rRF) is 7 percent and the market risk premium (rM - rRF) is 2 percent.  Which security would be the best investment? (Assume you must choose just one.)

a. Expected Return = 9.01%, Beta = 2, Required Return = 11%, Expected Less Required Return = -1.99%

c. Expected Return = 5.04%, Beta = 0.5, Required Return = 8%, Expected Less Required Return = -2.96%

e. Expected Return = 11.50%, Beta = 1, Required Return = 9%, Expected Less Required Return = 2.50%

d. Expected Return = 8.74%, Beta = 0.3, Required Return = 7.6%, Expected Less Required Return = 1.14%

b. Expected Return = 7.06%, Beta = 0.3, Required Return = 7.6%, Expected Less Required Return = -0.54%  = 9%   =11.20%    =6.37%

The security for which the expected return exceeds the required return by the largest amount, will be the best investment alternative.

As, Expected less Required Return is maximum(i.e 2.50%) for security e.

Therefore, E is the best option.

e. Expected Return = 11.50%, Beta = 1, Required Return = 9%, Expected Less Required Return = 2.50%

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