Financial Management case study 2 Essay Example | Topics and Well Written Essays - 750 words

Financial Management case study 2 - Essay Example base on the probability distribution of the rate of drive off, you earth-closet compute two key parameters, the evaluate rate of return and the standard deviation of rate of return. This in fact is the measure of risk for a single asset.StateProbabilityReturn on Stock AReturn on Stock B120%5%50%230%10%30%330%15%10%420%20%-10%Given a probability distribution of returns, the expected return can be calculated using the following equationWhere, E R is the expected return on the stock N = no of states pi is the probability of state i and Ri is return on the stock in state i. So we cypher that Stock B offers a higher expected return than Stock A. However, that is only part of the story we havent yet considered risk. Given an assets expected return, its variance can be calculated using the following equation and the standard deviation is calculated as the positive square root of the variance.Although Stock B offers a higher expected retu rn than Stock A, it also is riskier since its variance and standard deviation are greater than Stock As. Advantages of Risk and ReturnIt enables investors and entrepreneurs in fetching capital budgeting decisions.In case of risk chances of future losses can be foreseen.Disadvantages of Risk and ReturnUncertainty lies in decisions taken based on these.Calculations might be difficult at times.(b) Explain, with examples, how you would measure the risk of a portfolio.Most investors invest in a portfolio of assets, as they do not indispensability to wry face all their eggs in one basket. Hence what really matters to them is not the risk and return of stocks in isolation, but the risk and return of the portfolio as a whole.Expected return of a portfolio The expected return of a... Most investors invest in a portfolio of assets, as they do not want to pout all their eggs in one basket. Hence what really matters to them is not the risk and return of stocks in isolation, but the risk and return of the portfolio as a whole.Expected return of a portfolio The expected return of a portfolio is simply the weighted average of the expected returns on the assets comprising the portfolio. For eg when a portfolio consists of two securities then the expected return isConsider the following two stock portfolios and their respective returns (in per cent) over the last six months. Both portfolios end up increasing in cling to from $1,000 to $1,058. However, they clearly differ in volatility. Portfolio As monthly returns guide from -1.5% to 3% whereas Portfolio Bs range from -9% to 12%. The standard deviation of the returns is a better measure of volatility than the range because it takes all the values into account. The standard deviation of the six returns for Portfolio A is *1.52 for Portfolio B it is *7.24.