Problem on Risk in Investment

By
Shweta Kadao (MITSOB, 28th Batch)
December 2011

Numerical 1
Given below are historical returns for 2 Companies for 8years. Which company is riskier for
investment?

Returns
Year
1991
1992
1993
1994
1995
1996
1997
1998

(%)
Company Company
A
B
5
161
-16
50.3
7.8
-22
8.7
16.5
66.8
3.8
35.9
5
-8.1
76.2
-33.1
107.9

Solution:
To decide which Company is riskier we find Standard Deviation of their returns. Standard
deviation is applied to annual returns to measure the investment volatility. Variance and its
square root - standard deviation are measure of risk.

Mean =

Year
1991
1992
1993
1994
1995
1996
1997
1998
Mean

Company A
5
-16
7.8
8.7
66.8
35.9
-8.1
-33.1

Company B
161
50.3
-22
16.5
3.8
5
76.2
107.9

8.38

49.8

For Company A:
Actual
5
-16
7.8
8.7
66.8
35.9
-8.1
-33.1

Actual - Mean
-3.38
-24.38
-0.58
0.32
58.42
27.52
-16.48
-41.48

(Actual - Mean)^2
11.4244
594.3844
0.3364
0.1024
3412.8964
757.3504
271.5904
1720.5904
6768.6752

Variance = 2 =
Standard Deviation = =
of Company A

= 31.09

For Company B:
Actual
161
50.3
-22
16.5
3.8
5
76.2
107.9

Actual - Mean
161
50.3
-22
16.5
3.8
5
76.2
107.9

(Actual - Mean)^2
25921
2530.09
484
272.25
14.44
25
5806.44
11642.41
46,695.63

Variance = 2 =
Standard Deviation = =

= 81.67

of Company B

As Standard Deviation of Company A > Standard Deviation of Company B, therefore

Company B has more risky investments.