Q1.

Expected returns: John is watching an old game show rerun on television called Lets Make
a Deal in which the contestant chooses a prize behind one of two curtains. One of the curtains will
yield a gag prize worth $162, and the other will give a car worth $4,226. The game show has
placed a subliminal message on the curtain containing the gag prize, which makes the probability
of choosing the gag prize equal to 75 percent.
1. What is the expected value of the selection?
E(prize) = $ 1,178.00
E(prize) = 0.75($162) + 0.25($4,226) = $1,178.00
2. What is the standard deviation of that selection?
prize = $ 1,759.76
2prize = 0.75($162 - $1,178.00)2 + 0.25($4,226 - $1,178.00)2 = $3,096,768.00

prize = ($3,096,768.00)1/2 = $1,759.76

Q2. Moshe purchased a share for $30 last year. He found out today that he had a -100 per cent
return on his investment. Which of the following must be true?
a. The share is worth $30 today.

b. The share is worth $0 today

c. The share paid no dividends during the year.

d. Both b and c must be true.

Q3. Single-asset portfolios: Shares A, B, and C have expected returns

of 12.15 percent, 16.75 percent, and 9.60 percent, respectively, while their standard deviations
are 42.72 percent, 26.31 percent, and 27.56 percent, respectively. If you were considering the
purchase of each of these shares as the only holding in your portfolio, what is the coefficent of
variation of the most favourable share to include?
Coefficent of variation, CV = 1.57

Since the holding will be made in a completely undiversified portfolio, then we can calculate the
risk per unit of return for each share, the coefficient of variation, and choose the share with the
lowest value.

CV(RA) = 0.4272/0.1215 = 3.52

CV(RB) = 0.2631/0.1675 = 1.57

CV(RC) = 0.2756/0.096 = 2.87

Q4. Calculating the variance and standard deviation: Barbara is

considering investing in a share and is aware that the return on that
investment is particularly sensitive to how the economy is performing. Her
analysis suggests that four states of the economy can affect the return on
the investment. Using the table of returns and probabilities below, find the
expected return and the standard deviation of the return on Barbaras
investment.
Probability Return

Boom 0.2 25.00%

Good 0.5 15.00%
Level 0.2 10.00%
Slump 0.1 -5.00%

1. Expected return, E(Ri) =0.1400

E(Ri) = 0.20.25 + 0.50.15 + 0.20.1 + 0.1(-0.05) = 0.1400
2. Standard deviation, return =0.0800
2return = 0.2(0.25 - 0.1400)2 + 0.5(0.15 - 0.1400)2 + 0.2(0.1 - 0.1400)2 + 0.1(-0.05
- 0.1400)2 = 0.006400 return = (0.006400)1/2 = 0.0800

Q5. Francis purchased a share one year ago for $20, and it is now worth $24. The share paid a
dividend of $3 during the year. What was the share's rate of return from capital appreciation
during the year? (Round your answer to the nearest per cent.) 20%
Q6. Expected returns: You have chosen biology as your university major because you would like
to be a medical doctor. However, you find that the probability of being accepted to medical school
is about 9 percent. If you are accepted to medical school, then your starting salary when you
graduate will be $322,094 per year. However, if you are not accepted, then you would choose to
work in a zoo, where you will earn $36,788 per year. Without considering the additional
educational years or the time value of money, what is your expected starting salary as well as the
standard deviation of that starting salary?
1. Expected starting salary, E(salary) = $ 62,465.54
E(salary) = 0.91($36,788) + 0.09($322,094) = $62,465.54
2. Standard deviation, salary = $ 81,649.37
2salary = 0.91($36,788 - $62,465.54)2 + 0.09($322,094 - $62,465.54)2 =
$6,666,620,166.788400

salary = ($6,666,620,166.788400)1/2 = $81,649.37

Q7. Calculating the variance and standard deviation: Kate recently invested in real estate
with the intention of selling the property one year from today. She has modelled the returns on
that investment based on three economic scenarios. She believes that if the economy stays
healthy, then her investment will generate a 30 percent return. However, if the economy softens,
as predicted, the return will be 10 percent, while the return will be -25 percent if the economy
slips into a recession. If the probabilities of the healthy, soft, and recessionary states are 0.1, 0.6,
and 0.3, respectively, then what are the expected return and the standard deviation of the return
on Kates investment?

Expected return, E(Ri) = 0.01500 Standard deviation, return = 0.18331

E(Ri) = 0.10.3 + 0.60.1 + 0.3(-0.25) = 0.0150

0.1(0.3 - 0.0150)2 + 0.6(0.1 - 0.0150)2 + 0.3(-0.25

2return =
- 0.0150)2 = 0.033525

return = (0.033525)1/2 = 0.1831

Q8. If a random variable is drawn from a normal distribution, what is the probability that the
random variable is larger than 1.96 standard deviations below the mean? 97.50%
Q9. Portfolios with more than one asset: Given the returns and
probabilities for the three possible states listed here, calculate the
covariance between the returns of Share A and Share B. For convenience,
assume that the expected returns of Share A and Share B are 11.75
percent and 18 percent, respectively.
Probability Return(A) Return(B)
Good 0.1 0.30 0.50
Ok 0.6 0.10 0.10
Poor 0.3 -0.25 -0.30

Covariance, Cov(RA,RB) = 0.0596

Cov(RA,RB) = AB = 0.1(0.3 - 0.1175)(0.5 - 0.18) + 0.6(0.1 - 0.1175)(0.1 - 0.18) + 0.3(-
0.25 - 0.1175)(-0.3 - 0.18) = 0.0596
Q10. Which of the following statements concerning the standard deviation are correct? I. The
greater the standard deviation, the lower the risk. II. The standard deviation is a measure of
volatility. III. The higher the standard deviation, the less certain the rate of return in any one given
year. IV. The higher the standard deviation, the higher the expected return.
II, III, IV only