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Chapter 4: Q10BP (page 441)

Tim Trepid is highly risk-averse while Mike Macho actually enjoys taking a risk.

a. Which one of the four investments should Tim choose? Compute coefficients of variation to help you in your choice.

Investments

Returns:

Expected Value

Standard Deviation

Buy stocks ..................................... \( 9,140 \) 6,140

Buy bonds ..................................... 7,680 2,560

Buy commodity futures ................. 19,100 26,700

Buy options ................................... 17,700 18,200

b. Which one of the four investments should Mike choose?

Short Answer

Expert verified

a. Coefficient of variation


Buy stocks

0.6718

Buy bonds

0.333

Buy commodity futures

1.3980

Buy options

1.0282

Thus, Tim shall buy bonds because lower the coefficient of variation the better his risk- return trade off.

b. Mike should choose buying commodity futures.

Step by step solution

01

a.  Computation of coefficient of variation

CoefficientofvariationBuystocks=StandarddeviationExpectedvalue=61409140=0.6718

02

a. Computation of coefficient of variation

CoefficientofvariationBuybonds=StandarddeviationExpectedsales=25607680=0.333

03

a. Computation of coefficient of variation

CoefficientofvariationBuycommodityfutures=StandarddeviationExpectedsales=2670019100=1.3980

04

a. Computation of coefficient of variation

CoefficientofvariationBuyoptions=StandarddeviationExpectedsales=1820017700=1.0282

05

b. Investment decision

As Mike enjoys to take high risk, he will opt for purchase of commodity futures. The coefficient of variation of commodity future is higher in comparison to other options that means risk is comparatively higher.

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