The possible annual percentage return of the stocks of Gamma, Inc. and Delta, Inc. share a common probability distribution, given below.
Probability
Return of Gamma, Inc.
Return of Delta, Inc.
0.05
36.2
-6.4
0.15
23.4
-1.8
0.30
15.18
6.9
0.20
6.2
12.4
0.15
-2.0
16.8
0.05
-4.2
30.2
(A) What is the expected annual return of each stock?
?
(B) What is the standard deviation of the annual return of each stock?
?
(C) On the basis of your answers to parts (A) and (B), which of these stocks would you prefer to buy? Defend your choice.
?
(D) Are the annual returns of these two stocks positively or negatively associated with each other? How might the answer to this question influence your decision to purchase shares?
What will be an ideal response?
(A)
| Stock | Expected Value |
| Gamma | 10.58 |
| Delta | 10.10 |
(B)
| Stock | Standard Deviation |
| Gamma | 10.16 |
| Delta | 8.08 |
(C) Gamma has a higher expected annual return. However, Gamma is also more volatile with a higher standard deviation. Each stock also has a 20% chance of a negative return. Therefore, you could select Gamma based on the expected return or Delta based on the volatility.(D) These two stocks are negatively associated with one another. Therefore, if you want a more balanced portfolio, you may want to invest in both stocks.
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