Question

Following details are available about stock A: 20% chance that the return of the stock will be 14%, 15% chance that the return of the stock will be 15%, 25% chance that the return of the stock will be 16% and 40% chance that the return of the stock will be 17%.

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

Answer 1

Average return = Sum of probability*Return

= 20%*14%+ 15%*15%+ 25%*16%+ 40%*17%

= 0.028+0.0225+0.04+0.068

= 0.1585

=15.85%

Standard deviation of the stock= SQRT( Sum of Probability*(Return-Average return)^2))

= SQRT( 20%*(14%-15.85%)^2+15%*(15%-15.85%)^2+25%*(16%-15.85%)^2+40%*(17%-15.85%)^2)

=SQRT(0.00013275)

= 0.01152171862

=1.15%

The stock has low risk at just 1.15%. The expected return of the stock is 15.85% and a comparison with market returns will help in determining if this is good return.