1. Explain the relationship between risk and return. Whatcan an investor do to reduce risk?
2. How does the priority of different security holders inbankruptcy liquidation affect the required rate of return on different securities? In other words, why do bond investors have lower required rates ofreturn than do stock investors?
1. You have estimated the following probability distributions of expected future returns for Stocks X and Y:
Stock X Stock Y
Probability Return Probability Return
0.1 -10% 0.2 2%
0.2 10 0.2 7
0.4 15 0.3 12
0.2 20 0.2 15
0.1 40 0.1 16
- a. What is the expected rate of return for Stock X? Stock Y?
- b. What is the standard deviation of expected returns for Stock X? For Stock Y?
c. Which stock would you consider to be riskier? Why?