The relationship between risk and return is a fundamental

axiom in finance. Generally speaking, it is totally logical to assume that investors are only willing to assume additional risk if they are adequately compensated with additional return. This idea is rather fundamental, but the difficulty in finance arises from interpreting the exact nature of this relationship (accepting that risk aversion differs from investor to investor). Risk and return interact to determine security prices, hence its paramount importance in finance.


PROBABILITY DISTRIBUTION


The probability distribution is a listing of all possible outcomes and the corresponding probability.
Economic State Probability of this Rate of Return on stock   economic state occurring if this demand occurs


Estancia Salt Lamp Mines, Inc. Candelaria Candles Paseo Passive-Aggressive Plumbers Very Good 0.21 42% 70% -9% Good 0.22 21% 15% -5% Fair 0.30 8% 0% 8% Poor 0.10 -14% -12% 10% Very Poor 0.17 -28% -36% 18% 1.00


(a) What is the expected return and standard deviation of each stock? (b) Which stock has the best reward-for-risk? (c) You have a portfolio consisting of 45% Estancia Salt Lamp Mines, Inc., and 55% Paseo Passive-Aggressive Plumbers. What is the portfolio's expected return and standard deviation?
(d) Does the portfolio have a better reward for risk? Why or why not?