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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. 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]
Expert Solution
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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