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Homework answers / question archive / INSTRUCTION: Read the following questions carefully and write your answers clearly to each question

INSTRUCTION: Read the following questions carefully and write your answers clearly to each question

Accounting

INSTRUCTION: Read the following questions carefully and write your answers clearly to each question. Show all your workings and calculations.

Q1.       Consider the following scenario analysis concerning stocks and bonds:

STATE OF ECONOMY

PROBABILITY

RATE OF RETURN (%)

STOCK

BOND

Bad

0.20

--5%

14%

Normal

0.60

15%

8%

Good

0.20

25%

4%

You are required to calculate for both securities:

a)         The expected returns                                                                   [2 marks]

b)         The standard deviations                                                              [2 marks]

c)         The variance                                                                             [1 marks]

d)         The coefficient of variation                                                                      [1 marks]

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Answer a) Expected returns of:

Stock: -5%*0.20 + 15%*0.60 + 25%*0.20 = 13%.

Bond: 14%*0.20 + 8%*0.60 + 4%* 0.20 = 8.4%.

Answer b) Standard deviation of Stock:

Return Deviation probability*(deviation) ^2

-5 -18 64.8

15 2 2.4

25 12 28.8

Total 96

Standard deviation: √96 = 9.79

Devation = Return - expected return

Standard deviation of Bond:

Return Deviation probability*(deviation) ^2

14% 5.6 6.272   

8% -. 4 0.096   

4% -4. 4 3.872

Total 10.24

Standard deviation: √10.24 = 3.2

Ans c) Variance of stock : (9.79) ^2 = 96

Variance of bond: (3.2) ^2= 10.24

Ans d) Coefficient of variation = Standard deviation÷ Expected return

Stock: 9.79 ÷ 13 = 0.7530

Bond: 3.2÷ 8.4 = 0.3809

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