Question

Betty wants to know the probability that her investment in HighFlier, Inc. will generate a return less than zero. The investment has a mean return of 10% and a standard deviation of 5%. Based on a normal distribution curve you correctly inform her that:________.

A. There is a 2.5% probability of a negative return.
B. There is a 5% probability of a negative return.
C. There is a 10% probability of a negative return.
D. There is a 34% probability of a negative return.

Answer 1

A. There is a 2.5% probability of a negative return.

Step-by-step explanation:

The stock returns are often assumed to be normally distributed for the prediction of future returns. Although there are some weird characteristics of stock returns that normal distribution is unable to capture, it is widely used because of its easy to apply.

Given the following information,

E(R)=10%

σ=5%

Since returns are normally distributed and the normal distribution is symmetric, the probability that Stonehenge Construction will yield a negative return is two standard deviations below the mean.

In the case of the normal distribution, approximately 95% of observations lie within two standard deviations about the mean. Therefore, by symmetry, only 2.5% of observations have a probability of yielding a negative return for Stonehenge Construction. SO, the answer is (A).