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SAPM

Solution to Problems

Chapter 9: Risk

Q. 8. A stock costing Rs 50, pays no dividend. The possible prices of the stock at the end
of year and their probabilities are given below.

End of year price Probability


60 0.1
65 0.2
70 0.4
75 0.2
80 0.1

(a) Find out the expected return.


(b) Find out the standard deviation of the returns.

Solution:
ri P Expected (ri ri)2 P(ri ri)2
Return
(60 50) 10 0.1 1 100 10
(65 50) 15 0.2 3 25 5
(70 50) 20 0.4 8 0 0
(75 50) 25 0.2 5 25 5
(80 50) 30 0.1 3 100 10
ri = 20 30

= P (ri ri ) 2 = 30 = 5.48
(a) Expected Return = Rs 20
(b) = 5.48

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Q. 16. Mr. Mohan wants to buy Ant company stock which is currently selling at Rs 60
without dividend payment. There is equal probability for the Ant stock to be sold
at Rs 65 and Rs 80 during the next year. What is the expected return and risk if
300 shares are bought? Transaction cost is ignored.

Solution:
Risk :
ri Pi Expected Return (ri ri)2 P(ri ri)2
ri

5 0.5 2.5 56.25 28.125


20 0.5 10.0 56.25 28.125
12.5 56.25

= 56.25 = 7.5
(a) Expected Return = 12.5 300 = Rs 3750
(b) If 300 shares are bought, Risk = 7.5 300 = Rs 2250
Q. 17. An investor wants to choose either X or Y companys stock. Both the companies
are not paying dividends. X company stock is currently selling for Rs 150 and Y
for Rs 200. At the end of the year ahead there is a probability for X to be sold
either for Rs 171 or Rs 167 and Y either for Rs 227 or Rs 223. Which companys
scrip should the investor buy? Justify your answer.

Solution: In case of x:

ri Pi ri ri (ri ri)2 Pi (ri ri)2

21 0.5 10.5 4 2

17 0.5 8.5 4 2

ri = 19.0 4

Expected Return = 19
Risk: = 4 = 2

2
In case of y:

ri Pi ri ri (ri ri)2 P(ri ri)2


27 0.5 13.5 4 2
23 0.5 11.5 4 2
25.0 4

Expected Return = Rs 25
Risk: = 4 =2

With the same level of risk (2), Y provides more return. So, the investor can buy
the stock Y.

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