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Homework answers / question archive / Du-Point asset management company intends to invest in two stocks with the following risk and return trade off; Probability Stock A Stock B 0
Du-Point asset management company intends to invest in two stocks with the following risk and return trade off;
Probability Stock A Stock B
0.1 33% 60%
0.2 20% 30%
0.4 15% 5%
0.3 0% -20%
Required
a) Calculate the expected return of each stock (3 Marks)
b) Calculate the risk of each stock ( 4 Marks)
c) Calculate coefficient of variation of each stock ( 2 Marks)
d) Calculate the expected return of the portfolio consisting of 50% of each stock
e) If you are risk averse investor which stock would you prefer to hold and why
f) Distinguish between systematic risk and un-systematic risk giving three examples in each case
a. Expected return of Security A=
33*0.1+20*0.2+15*0.4+0*0.3= 13.3%
Expected return of Security B=
60*0.1+30*0.2+5*0.4-20*0.3= 8%
b. Risk of Security A
| Probablity | Given Return | Expected Return | Da | Da^2 | PDa^2 |
| p | (a) | (b) | (a)-(b)=(c) | (c)*(c)=(d) | P*(d) |
| 0.1 | 33 | 13.3 | 19.7 | 388.09 | 38.809 |
| 0.2 | 20 | 13.3 | 6.7 | 44.89 | 8.978 |
| 0.4 | 15 | 13.3 | 1.7 | 2.89 | 1.156 |
| 0.3 | 0 | 13.3 | -13.3 | 176.89 | 53.067 |
| 102.01 |
Risk = 102.01^1/2= 10.1%
Risk of Security b
| Probablity | Given Return | Expected Return | Da | Da^2 | PDa^2 |
| p | (a) | (b) | (a)-(b)=(c) | (c)*(c)=(d) | P*(d) |
| 0.1 | 60 | 8 | 52 | 2704 | 270.4 |
| 0.2 | 30 | 8 | 22 | 484 | 96.8 |
| 0.4 | 5 | 8 | -3 | 9 | 3.6 |
| 0.3 | -20 | 8 | -28 | 784 | 235.2 |
| 606 |
Risk = 606^1/2= 24.617%
c. Coefficient of Variance of Stock A= risk/return= 10.1/13.3= 0.7594
Coefficient of Variance of Stock b= risk/return= 24.617/8=3.077125
d. Return of Portfolio consisting of 50% of Security A & B
= Retun of A *0.5+Retun of B *0.5\
= 13.3*0.5+8*0.5
= 10.65%
e. Since the Coefficient of Variance of Stock A is lower than Coefficient of Variance of Stock B. Thus an risk adverse Investor would prefer Stock A over Stock B.
f. Systematic risk is a risk that can never be controlled or eliminated whereas unsystematic risk can be controlled.Unsystematic risk is company specific whereas Systematic risk is country or sector specific. For example, Unsystematic risk is Labour strike or electricity isssues whick can be avoided whereas Systematic risk is like political instability which cannot be avoided by a company. GDP miovement is also an example of Systematic risk.
