CHAPTER 2 – RISK AND RETURN

2. For each of the following probability distributions, calculate the expected value and standard
deviation:

Outcome Probability Outcome value

a. Good 30% 40 USD

Normal 50% 20 USD

Bad 20% 10 USD

Mean = $24

SD = $11

b. 1 10% 60%

2 50% 40%

3 30% 20%

4 10% -40%

Mean = 0.28

SD = 25.61%

c. A 10% $1000

B 20% $2000

C 40% $3000

D 20% $4000

E 10% $5000

Mean = $3000

SD = $1095

d. Pessimistic 10% 1,000,000 USD

Moderate 40% 4,000,000 USD

Optimistic 50% 6,000,000 USD

Mean = $4,700,000

SD = $1,552,417
3. There is a 50% probability that the Plum Company’s sales will be 10 mil. USD next year, a 20%
probability that they will be 5 mil. USD and a 30% probability that they will be 3 mil. USD

a. What are the expected sales of Plum Company next year? Mean = 6.9 mil. USD

b. What is the standard deviation of Plum’s next year’s sales? SD = 3.1765 mil. USD

4. Consider the following investments:

Investment Expected Return Standard deviation

A 5% 10%

B 7% 11%

C 6% 12%

D 6% 10%

Which investment would you prefer between the following pairs:

a. A and D D

b. B and C B

c. C and D D

5. The covariance of the returns on the 2 securities, A and B, is -0.0005. The standard deviation of A’s
returns is 4% and the standard deviation of B’s returns is 6%. What is the correlation coefficient
between the returns of A and B?

Rho(A,B) = -0.2083

6. What is the expected return of the portfolio conmprised of 3 following securities:

Securities Value Expected return

A 150 mil. VND 12%

B 100 mil. VND 13.5%

C 200 mil. VND 9%

Expected return = 11%

7. Consider securities A and B with the following estimates:

E(RA) = 8% σA = 12% E(RB) = 13% σB = 20%

Now consider the portfolios that can be formed with A and B, assuming that the investment is equal
between A and B (that is, each has a weight of 50%). What is the portfolio’s standard deviation if the
correlation coefficient between A and B for each of the following:

a. ρAB = 1 -> SD(p) = 0.16 (max)

b. ρAB = 0.3 -> SD(p) = 0.13115

c. ρAB = 0 -> SD(p) = 0.11662

d. ρAB = -1 -> SD(p) = 0.04 (min)

8. Consider Securities X and Y with the following estimates:

E(RX) = 5% σX = 10% E(RY) = 15% σY = 25%

If the portfolio is comprised of 40% X and 60% Y and if the correlation coefficient between the returns
on X and Y is -0.25, what is the portfolio’s expected return and risk?

Expected return = 11%

SD = 14.527%