Question

Phoenix Company common stock is currently selling for $20 per share. Security analysts at Smith Blarney have assigned the following probability distribution to the price of (and rate of return on) Phoenix stock one year from now: Price Rate of Return Probability $16 –20% 0.25 20 0% 0.30 24 +20% 0.25 28 +40% 0.20 Assuming that Phoenix is not expected to pay any dividends during the coming year, determine the coefficient of variation for the rate of return on Phoenix stock.

Answer 1

Risk on stock is 21.4%

Explanation:

Expected return on phoenix stock =

= - 20% ×0.25 + 0%×0.30 + 20%×0.25 + 40%×0.20

= - 5% + 0% + 5% + 8%

= 8%

Risk on stock is calculated as

Risk = [0.25(-20% -8%)^2 +0.30(0%-8%)^2 + 0.25(20% - 8%)^2 + 0.20(40% - 8%)^2]^{1/2}

`= [0.25* 784 + 0.30* 64 + 0.25* 144 + 0.20* 1024]^(1/2)`

`= [196 + 19.20 + 36 + 204.80]^(1/2)`
`= 456^(1/2)`

=21.4%