Westminster International University in Tashkent Corporate Finance 4econ009C-n 2021/2012, Semester 2

Required. Using the information provided by James so far, finish up measuring the expected return and risk of the bond. Fill in the table with appropriate calculations to arrive at the expected return and risk. Answer. See the filled in table above.

7. 
   Part A. Estimates of the possible returns from investing in the common stock of Rosy Corporation are given as such:
   

Probability of occurrence Possible return

0.05 -5%
0.11 0%
0.19 8%
0.30 19%
0.19 30%
0.11 40%
0.05 50%


Required f ind the expected return on this stock investment and its respective risk (standard deviation);


Answer. Expected return,

E( )=(0.0025)+0+0.0152+0.057+0.057+0.044+0.025=0.1957 or 19.57%

Standard deviation, σ =


(-0.05-0.1957)²*0.05+(0-0.1957)²*0.11+(0.08-0.1957)²*0.19+(0.19-0.1957)²*0.30+(0.30-0.1957)²*0.19+(0.40-0.1957)²*0.11+(0.50-0.1957)²*0.05= =0.1449 or 14.5%
Part B. Now, suppose you have heard about other new, but potentially growing companies called Daisy Industries and Lilly Bloomy. You want to weigh your options in investing in either of these companies (Rosy Corporation, Daisy Industries and Lilly Bloomy). The estimates of returns are as follows for the new companies:


Daisy Industries Lilly Bloomy

Probability Possible return
0.01 -10%
0.11 2%
0.20 11%
0.36 20%
0.20 28%
0.11 39%
0.01 48%

Probability Possible return
0.07 0%
0.10 5%
0.19 15%
0.28 25%
0.19 33%
0.10 41%
0.07 50%




Required: compare and contrast the expected returns and risks (coefficient of variation) of above 3 stocks. As a risk averse investor, which company would be your best alternative to invest? What option would a risk neutral investor choose?


Expected return,

Expected return Daisy Industries,

=-0.001+0.0022+0.0220+0.0720+0.0560+0.0429+0.0048=0.1989 or 19.89%

Expected return Lilly Bloomy

=0+0.0050+0.0285+0.0700+0.0627+0.0410+0.0350=0.2422 or 24.22%
Standard deviation, σ =
Standard Deviation Daisy Industries
0.0009+0.0035+0.0016+0.0000+0.0013+0.0040+0.0008= =0.11 or 11%

Standard deviation Lilly Bloomy

= =0.1356 or 13.56%

Compare coefficients of variation (CV) =

Rosy: = 0.74; Daisy: = 0.55; Lilly: = 0.56

A risk averse investor will choose Daisy Industries stock, while a risk neutral one will invest in Lilly Bloomy because of CVs.

Part C. Now, since you have learned from your finance related classes that you can minimize your investment risk by holding more stock than only one. So, you want to create a portfolio and see which combination of those stocks would give you the least risk without changing the expected returns.