Textbook Exercise Solutions Part 2 - TOPIC 5 3-9(i...

Info icon This preview shows pages 1–4. Sign up to view the full content.

View Full Document Right Arrow Icon
TOPIC 5 3-9 (i) Risk/return graph Risk / Return A B D C E F 0% 5% 10% 15% 20% 25% 0% 5% 10% 15% 20% 25% Risk Return (ii) An investor willing to take risks would invest in the two shares of F and C, as F offers the highest return with the highest standard deviation. C offers a lower return and a lower level of risk. E would not be selected as it offers the same return as C but at a higher level of risk. (iii) A cautious investor would select A and C, as A offers the lowest return at the lowest level of risk. C offers a return of 15% with a standard deviation of 15%. Investment B would not be selected as it offers a lower return than C but at a higher level of risk. (iv) No. It means that investors will require higher returns for taking on higher risk investments. (v) Government bonds are considered to be low risk, as the government will always pay the redemption value of such bonds, either by printing money or increasing tax rates. The risk of government not being able to meet its commitments is very small. However, the values of long term bonds will be highly variable, due to the sensitivity of such bond values to changes in interest rates. 1
Image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
3-11 1., 2., & 3. 1 2 1 x 2 Return - ER Deviation 2 x Prob. Expected return Deviation Weighted Sq. Deviation Probability Return X 0.20 10% 2.00% -5.00% 0.05% 0.60 15% 9.00% 0.00% 0.00% 0.20 20% 4.00% 5.00% 0.05% Expected Return (sum) 15.00% Variance = sum of sq. deviations 0.10% Std Dev = Var 0.5 3.16% Coefficient of Variation (Stdev/ER) 21% Workings Expected return 0.2 x 10% = 2% Deviation 10% - 15% = -5% Squared deviation x Prob. (-.05) 2 x 0.20 = 0.0005 1 2 1 x 2 Return - ER Deviation 2 x Prob. Expected return Deviation Weighted Sq. Deviation Probability Return X 0.20 0% 0.00% -15.00% 0.45% 0.30 10% 3.00% -5.00% 0.08% 0.30 20% 6.00% 5.00% 0.08% 0.20 30% 6.00% 15.00% 0.45% Expected Return (sum) 15.00% Variance = sum of sq. deviations 1.05% Std Dev = Var 0.5 10.25% Coefficient of Variation (Stdev/ER) 68% Workings Expected return 0.3 x 10% = 3% Deviation 10% - 15% = -5% Squared deviation x Prob. (-.05) 2 x 0.30 = 0.0008 Share X Share Y 4. Share X and Share Y offer the same expected return of 15%. However, the risk associated with investing in Share Y is significantly greater than investing in Share X. The higher risk in absolute terms is measured in terms of a standard deviation of 10.25% for Share Y as compared to a much lower standard deviation of 3.16% for Share X. As the expected returns are equal in this case, the additional calculation of the coefficient of variation is not required but has been calculated in this case. The CV of Share Y is significantly higher than the CV of Share X. 2
Image of page 2
5. 1 2 1 x 2 Return - ER Deviation 2 x Prob. Expected return Deviation Weighted Sq. Deviation Probability Return X 0.20 0% 0.00% -17.00% 0.58% 0.30 10% 3.00% -7.00% 0.15% 0.30 20% 6.00% 3.00% 0.03% 0.20 40% 8.00% 23.00% 1.06% Expected Return (sum) 17.00% Variance = sum of sq. deviations 1.81% Std Dev = Var 0.5 13.45% Coefficient of Variation (Stdev/ER) 79% Share Y The expected return increases to 17%, but the risk also increases. The standard deviation is now 13.45%, and the CV is 79%. The investment decision would probably not change due to the fact that the additional 2% return will result in a significantly higher risk. A comparison of the Coefficient of Variation ratios for both companies indicates that the level of risk relative to
Image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 4
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern