Answers to Chapter Review and Self Test Problems

13.1 The expected returns are just the possible returns multiplied by the associated probabilities:

E(Ra) = (.20 X -.15) + (.50 X .20) + (.30 X .60) = 25%

E(RB) = (.20 X .20) + (.50 X .30) + (.30 X .40) = 31%

The variances are given by the sums of the squared deviations from the expected returns multiplied by their probabilities:

ctA = .20 X (-.15 - .25)2 + .50 X (.20 - .25)2 + .30 X (.60 - .25)2 = (.20 X - .402) + (.50 X - .052) + (.30 X .252) = (.20 X .16) + (.50 X .0025) + (.30 X .1225) = .0700

CT2 = .20 X (.20 - .31)2 + .50 X (.30 - .31)2 + .30 X (.40 - .31)2 = (.20 X .112) + (.50 X -.012) + (.30 X .092) = (.20 X .0121) + (.50 X .0001) + (.30 X .0081) = .0049

The standard deviations are thus:

"A

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

V. Risk and Return

13. Return, Risk, and the Security Market Line

© The McGraw-Hill Companies, 2002

CHAPTER 13 Return, Risk, and the Security Market Line

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