SOLUTION: FIN 310 Great Basin College – Mod 7 – Financial Investment Comparison

Chapter 8 Homework Assignment
According to Carlo’s stock broker, Investment A has relatively high historical rates of return, and
so he is recommending the purchase of Investment A. Carlo’s insurance advisor, on the other
hand, is recommending the purchase of Investment B based on its historical rates of return.
And still another advisor is recommending the purchase of a third investment (Investment C)
based on its historical returns. Carlo is trying to determine which of the three investments is
best, and he is focusing his decision making process on the concepts of risk and return.
[Note: This assignment is four pages long. You can either use this document for your submission
or you can create your own Excel spreadsheet. Since there are many calculations on this
assignment, it is recommended that you use Excel to organize your calculations.]
Investment A is an equity (stock) investment in an American company. Returns on this
Investment for the past 6 years are detailed in the table below, and Carlo expects the returns of
the next 6 years to be the same as the last 6 years.
Year
1
2
3
4
5
6
Return
+80%
-50%
+70%
-50%
+40%
-5%
1. With respect to Investment A, if the annual returns are each considered to be equally
likely to occur, calculate the standard deviation of the returns. ____________
2. What is the expected average annual rate of return on Investment A? __________
3. An investor who invested $10,000 in Investment A at the beginning of year 1 would
have how much in the investment at the end of year 6? _____________
4. Taking only the beginning and ending balances of the investment into account in order
to smooth the returns and to avoid the problem of multiple rates of return that can
occur when returns are both positive and negative, what is the compound annual
growth rate of Investment A over the 6-year period? ____________
5. What is the relevant annual rate of return per unit of risk (expressed as one number) for
Investment A over the 6-year period? _____________
Investment B is represented by the cash value of a whole life insurance policy. Returns on this
Investment for the past 6 years are detailed in the table below, and Carlo expects the returns of
the next 6 years to be the same as the last 6 years.
Year
1
2
3
4
5
6
Return
+4.9%
+5.0%
+4.6%
+5.1%
+4.9%
+4.8%
6. With respect to Investment B, if the annual returns are each considered to be equally
likely to occur, calculate the standard deviation of the returns. ____________
7. What is the expected average annual rate of return on Investment B? ___________
8. An investor who invested $10,000 in Investment B at the beginning of year 1 would have
how much in the investment at the end of year 6? ______________
9. Taking only the beginning and ending balances of the investment into account in order
to smooth the returns and to avoid the problem of multiple rates of return that can
occur when returns are both positive and negative, what is the compound annual
growth rate of Investment B over the 6-year period? ___________
10. What is the relevant annual rate of return per unit of risk (expressed as one number) for
Investment B over the 6-year period? ____________
Investment C is an equity (stock) investment in a British company. Returns on this Investment
for the past 6 years are detailed in the table below, and Carlo expects the returns of the next 6
years to be the same as the last 6 years.
Year
1
2
3
4
5
6
Return
+70%
-45%
+80%
-42%
+50%
-8%
11. With respect to Investment C, if the annual returns are each considered to be equally
likely to occur, calculate the standard deviation of the returns. ____________
12. What is the expected average annual rate of return on Investment C? ___________
13. An investor who invested $10,000 in Investment C at the beginning of year 1 would have
how much in the investment at the end of year 6? _____________
14. Taking only the beginning and ending balances of the investment into account in order
to smooth the returns and to avoid the problem of multiple rates of return that can
occur when returns are both positive and negative, what is the compound annual
growth rate of Investment C over the 6-year period? _____________
15. What is the relevant annual rate of return per unit of risk (expressed as one number) for
Investment C over the 6-year period? ____________
16. Summarize your results from above in a table that shows the relevant details.
[Note: The table below is where most of the grading for this assignment will be focused,
so please do not overlook its importance.]
A
B
C
Standard Deviation
Average Annual Rate of Return
End of Year 6 Value
Compound Annual Growth Rate (CAGR)
Relevant Annual Return per Unit of Risk
17. Thus far in this assignment, if done properly, you have calculated two different types of
annual returns for the three investments. Which of the two types of returns is the most
relevant in terms of guiding Carlo in his selection process relative to choosing the best
alternative among the three investments?
_______________________________________
18. If the rate of return per unit of risk is considered to be the appropriate measurement of
the goodness of an investment, then which of the three investments is the best choice
for a rational investor? _________________

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