Risk Management and Insurance

Assignment

1. Your rate of returns expectation for the common stock of Gray Disc Company during the next year is ,

Possible rate of returns | Probability |

-0.10 | 0.25 |

0.00 | 0.15 |

0.10 | 0.35 |

0.25 | 0.25 |

a. Compute the expected returns on these investments, the variance of these returns and its standard deviation.

b. Under what conditions can the standard deviation be used to measure the relative risk of two investments.

c. Under what conditions must the co-efficient of variation(cv) be used to measure the relative risk of two investments

2. Your rate of returns expectations for the stock of Kayliegh Computer Company during the next year is,

Possible rate of returns | Probability |

-0.60 | 0.15 |

-0.30 | 0.10 |

-0.10 | 0.05 |

0.20 | 0.40 |

0.40 | 0.20 |

0.80 | 0.10 |

a. Compute the expected returns on this stock, the variance on this return and its standard deviation.

b. On the bases of expected return alone discuss whether Gray Disc or Kayliegh Computer Company is preferable.

c. On the bases of standard deviation only discuss whether Gray Disc or Kayliegh Computer Company is preferable.

d. Compute the co-efficient of variation for Gray and discuss which stock return series has the greater relative dispersion.

SOLUTION

(A) Grey Disc Company

Ri Pi PiRi [R-E(Ri)] [R-E(Ri)]2 Pi[R-E(Ri)]2

-0.10 0.25 -0.025 -0.1725 0.02975625 0.0074390625

0.00 0.15 0.00 -0.0725 0.00525625 0.0007884375

0.10 0.035 0.035 -0.0275 0.00075625 0.0002646875

0.25 0.25 0.0625 0.1775 0.03150625 0.00787656125

0.0725 0.067275 0.01636875

PiRi...