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Chapter6: Risk and Return
[Link] bought 400 shares of Metallica Heavy Metal, Inc., at $30 per share. Over the year, you
received $0.75 per share in dividends. If the stock sold for $33 at the end of the year, what was your
dollar return? Your percentage return?
Answers
Dollar return = Dividend income + Change in Market Value
= ($0.75 x 400) + [($33-$30) x 400]
= $300 + $1,200
= $1,500
dividend + change in market value
Percentage return =
beginning market value
($0.75 + $33 − $30) × 400
=
$30 × 400
= 12.5%
2. Using the following returns, calculate the average returns, the variances, and the standard
deviations for the following stocks:
Year Michele, Inc. Janicek Co.
1 12% 5%
2 -4 -15
3 0 10
4 20 38
5 2 17
Answers
Average return
Michele, Inc. Janicek Co.
12% 5%
-4 -15
0 10
20 38
2 17
30% 55%
Average return Average return
30%/ 5 = 6% 55%/5 = 11%
Variances(σ 2)
Year Michele, Inc. Janicek Co.
(R-R)2 (R-R)2
2
1 (12 - 6) = 36 (5 - 11)2 = 36
2 (-4 - 6)2 = 100 (-15 - 11)2 = 676
2
3 (0 - 6) = 36 (10 - 11)2 = 1
4 (20 - 6)2 = 196 (38 - 11)2 = 729
5 (2 - 6)2 = 16 (17 - 11)2 = 36
384 1,478
Michele Janicek
2 2
σ =384 / 5 = 76.8% σ = 1,478 / 5 = 295.6%
Standard deviations (σ )
Michele Janicek
σ = 76.8 = 8.76% σ = 295.6 = 17.19%
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3. Suppose you bought 200 shares of stock at an initial price of $42 per share. The stock paid a
dividend of $2.40 per share during the following year, and the share price at the end of the year was
$31. Compute your total dollar return on this investment.
Answers
Dollar return = 200($31 – $42) + 200($2.40) = –$1,720.
4. In the problem 3, what is the capital gains yield? The dividend yield? What is the total rate of
return on the investment?
Answers
Capital gains yield = ($31 – $42)/$42 = –26.19%
Dividend yield = $2.40/$42 = 5.71%
Total rate of return = –26.19% + 5.71% = –20.48%
5. Rework Problems 3 and 4 assuming that you buy 750 shares of the stock and the ending share
price is $60.
Answers
Dollar return = 750($60 – $42) + 750($2.40) = $15,300
Capital gains yield = ($60 – $42)/$42 = 42.86%
Dividend yield = $2.40/$42 = 5.71%
Total rate of return = 42.86% + 5.71% = 48.6%
6. Calculating Returns and Variability Using the following returns, calculate the average
returns, the variances, and the standard deviations for stocks A and B.
Year A B
1 14% 22%
2 3 -5
3 -6 -15
4 11 28
5 9 17
Answers
A: Average return = 6.20%,
Variance = 50.16%
Standard deviation = 7.08%
B: Average return = 9.40%,
Variance = 273.04%
Standard deviation = 16.52%
7. Risk Premiums Consider the following common stock and T-bill returns for the period
2004 - 2010:
Year Common Stocks T-Bills
2017 32.6% 12.0%
2018 -5.0 15.2
2019 21.7 11.3
2020 22.6 v8.9
2021 6.2 10.0
2022 31.9 7.7
2023 18.7 6.2
a. Calculate the observed risk premium in each year for the common stocks.
b. Calculate the average returns and the average risk premium over this period.
c. Calculate the standard deviation of returns and the standard deviation of the risk premium.
d. Is it possible that the observed risk premium can be negative? Explain how this can happen
and what it means.
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Answers
a. Annual risk premium = common stock return – T-bill return
Year Common stocks T-bill return Risk premium
2017 32.6% 12.0% 20.6%
2018 –5.0 15.2 –20.2
2019 21.7 11.3 10.4
2020 22.6 8.9 13.7
2021 6.2 10.0 – 3.8
2022 31.9 7.7 24.2
2023 18.7 6.2 12.5
128.7 71.3 57.4
b. Average returns:
- Common stocks = 128.7% / 7 = 18.4%
- T-bills = 71.3% / 7 = 10.2%
- Risk premium = 57.4% / 7 = 8.2%
c. Calculate the standard deviation of returns
-Common stocks:
Variance = [(32.6%–18.4%)2 + (–5%–18.4%)2 + (21.7%–18.4%)2 + (22.6%–18.4%)2
+ (6.2%–18.4%)2 + (31.9%–18.4%)2 + (18.7%–18.4%)2 ] /7= 158.41%
Standard deviation = (158.41%)1/2 =12.60%
-T-bills:
Variance = [(12%–10.2%)2 + (15.2%–10.2%)2 + (11.3%–10.2%)2 +(8.9%–10.2%)2 + (10%–
10.2%)2 + (7.7%–10.2%)2 + (6.2%–10.2%)2 ] /7= 7.63%
Standard deviation = (7.63%)1/2 = 2.76%
-Risk premium:
Variance = [(20.6%–8.2%)2 + (-20.2%–8.2%)2 + (10.4%–8.2%)2 + (13.7%–8.2%)2 +
(–3.8%–8.2%)2 + (24.2%–8.2%)2 + (12.5%–8.2%)2 ]/7 = 202%
Standard deviation = (202%)1/2 = 14.21%
8. Two assets are being considered by Boxcar Industries. The following probability distributions of
returns for each of the assets is presented.
Asset A Asset B
Year Probability Rate of Return Probability Rate of Return
1 0.30 40% 0.40 30%
2 0.20 25% 0.20 20%
3 0.10 10% 0.20 10%
4 0.40 -5% 0.20 -10%
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a. Calculate the expected return and the standard deviation for each of the asset’s returns.
Which asset is riskier?
b. Calculate the coefficient of variance (CV) for each of the assets. Which asset has the highest
relative risk?
Answers
a, Calculate the expected return and the standard deviation for Asset B and Asset C
+ Expected return(E(R))
E(R) = (P1 x R1) + (P2 x R2) + -------- + (Pt x Rt)
-Asset A
E(R) = (0.30 x 0.40) + (0.20 x 0.25) + (0.10 x 0.10) + (0.40 x -0.05)
=16%
-Asset B
E(R) = (0.40 x 0.30) + (0.20 x 0.20) + (0.20 x 0.10) + (0.20 x -0.10)
= 16%
+ Standard deviation
σ = σ2
σ 2= (R1 – E(R))2 P1 + (R2 – E(R))2 P2 + ----- +(Rn – E(R))2 Pn
-Asset A
Year (R1 – E(R))2 P1
1 (40-16)2 0.30 = 172.8
2 (25-16)2 0.20 = 16.2
3 (10-16)2 0.10 = 3.6
4 (-5-16)2 0.40 = 176.4
369
σ2 =369%
σ = 369 % = 19.20%
-Asset B
Year (R1 – E(R))2 P1
1 (30-16)2 0.40 = 78.4
2 (20-16)2 0.20 = 3.2
3 (10-16)2 0.20 = 7.2
4 (-10-16)20.20 =135.2
224
σ 2=224%
σ = 224 % =14.97%
b, Calculate the coefficient of variance (CV) for Asset A and Asset B
σ
CV=
E(R)
-Asset A
CV = 19.20% /16% =1.2
-Asset B
CV = 14.97% / 16% = 0.935
Asset A has higher risk than asset B
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