Expected rate of return and risk Summerville Inc is consider

(Expected rate of return and risk) Summerville Inc. is considering an investment in one of two common stocks. Given the information in the popup window: E, which investment is better, based on the risk (as measured by the standard deviation) and return of each? a. The expected rate of return for Stock A is %. (Round to two decimal places) The expected rate of return for Stock B is %. (Round to two decimal places) b. The standard deviation for Stock A is | %. (Round to two decimal places) The standard deviation for Stock B is 1 %. (Round to two decimal places) c. Based on the risk (as measured by the standard deviation) and return of each stock, which investment is better? (Select the best choice below.) O A. Stock A is better because it has a higher expected rate of return with less risk. O B. Stock B is better because it has a lower expected rate of return with more risk.

Solution

Answer a.

Stock A:

Expected Return = 0.20 * 12% + 0.60 * 16% + 0.20 * 20%
Expected Return = 16.00%

Stock B:

Expected Return = 0.20 * (-4%) + 0.30 * 5% + 0.30 * 15% + 0.20 * 22%
Expected Return = 9.60%

Answer b.

Stock A:

Variance = 0.20 * (0.12 - 0.16)^2 + 0.60 * (0.16 - 0.16)^2 + 0.20 * (0.20 - 0.16)^2
Variance = 0.00064

Standard Deviation = (0.00064)^(1/2)
Standard Deviation = 0.0253
Standard Deviation = 2.53%

Stock B:

Variance = 0.20 * (-0.04 - 0.096)^2 + 0.30 * (0.05 - 0.096)^2 + 0.30 * (0.15 - 0.096)^2 + 0.20 * (0.22 - 0.096)^2
Variance = 0.00828

Standard Deviation = (0.00828)^(1/2)
Standard Deviation = 0.0910
Standard Deviation = 9.10%

Answer c.

Answer a.

Stock A:

Expected Return = 0.20 * 12% + 0.60 * 16% + 0.20 * 20%
Expected Return = 16.00%

Stock B:

Expected Return = 0.20 * (-4%) + 0.30 * 5% + 0.30 * 15% + 0.20 * 22%
Expected Return = 9.60%

Answer b.

Stock A:

Variance = 0.20 * (0.12 - 0.16)^2 + 0.60 * (0.16 - 0.16)^2 + 0.20 * (0.20 - 0.16)^2
Variance = 0.00064

Standard Deviation = (0.00064)^(1/2)
Standard Deviation = 0.0253
Standard Deviation = 2.53%

Stock B:

Variance = 0.20 * (-0.04 - 0.096)^2 + 0.30 * (0.05 - 0.096)^2 + 0.30 * (0.15 - 0.096)^2 + 0.20 * (0.22 - 0.096)^2
Variance = 0.00828

Standard Deviation = (0.00828)^(1/2)
Standard Deviation = 0.0910
Standard Deviation = 9.10%

Answer c. The correct answer is A.

Stock A is better because it has higher expected rate of return with less risk.