Question

You have to add on one of the two securities in your portfolio - 1. Security gives expected return of 15% with SD of 18%, and 2. Security ages de return of 20% with SD of 25%. Give reasons for your answers 7 i BIG SE

Answer 1

An Investors would like to get higher returns from security and bear lower risk (Standard deviation). Now the data given in the question states that

Security A - Expected Return 15% and Standard Deviation 18%

Security B - Expected Return 20% and Standard Deviation 25%

On the basis of Return Security B is preferred as it provides higher returns.

On the basis of Standard Deviation Security A is preferred since the risk is lower as compared to Security B.

However we have to choose one security to add in our portfolio. Final decision is made on the basis of coefficient of variation which is risk as a percentage of return.

Coefficient of Variation = (Standard Deviation / Mean) * 100

The Security with lower Coefficient of Variation should be selected.

Coefficient of Variation Security A = (18 / 15) * 100

= 120%

Coefficient of Variation Security B = (25 / 20) * 100

= 125%

Therefore we will choose Security A as it has lower Coefficient of Variation.