SECURITY ANALYSIS

Solutions to Problems

1.

a)

Possible Return Ri Probability Pi (Ri)(Pi) (Ri-Ŕ) 2 (Pi)

-0.10 .10 (-0.10-0.11)2(0.10)
.0.0 .20 00 (0.00-0.11)2(0.20)
.10 .30 0.03 (0.10-0.11)2(0.30)
.20 .30 0.06 (0.20-0.11)2(0.30)
.30 .10 0.03 (0.30-0.11)2(0.10)
∑ = 1.00 ∑ =Ŕ= 0.11 ∑ = 0.0129 = σ2
√(0.0129)= σ=11.36%

b) There is a 30 percent probability that the actual return will be zero (prob. E(R) = 0 is 20%) or
less (prob. E(R) < is 10%). Also, by inspection we see that the distribution is skewed to the left.

2.
a) For a return that will be zero or less, standardizing the deviation from the expected value of
return we obtain (0% -20%)/15% = -1.333 standard deviations.
1.333 falls between standard deviations of 1.30 and 1.35. These standard deviations
correspond to areas under the curve of .0968 and .0885 respectively. This means that there is
approximately a 9% probability that actual return will be zero or less. (Interpolating for 1.333,
we find the probability to be 9.13%.)
Interpolate
0.03 1.30 0.0968 X
0.05 1.33 A 0.0083
1.35 0.0885

1.33 – 1.30 = 0.03

1.35-1.30 = 0.05
0.0968-0.0885 = 0.0083
0.0968- X = A

0.02 = X
0.05 0.0083

X = 0.4(0.0083) = 0.00332
A = 0.0083- X
 =0.0083– 0.00332 =0.00498 = 0.498%

Possibility of negative return is 0.498%

b)

10 percent: Standardized deviation = (10% - 20%)/15% = -0.667.

Probability of 10 percent or less return = (approx.) 25 percent.
Probability of 10 percent or more return = 100% - 25% = 75percent.

20 percent: 50 percent probability of return being above 20 percent.

30 percent: Standardized deviation = (30% - 20%)/15% =+0.667.

Probability of 30 percent or more return = (approx.) 25 percent.

40 percent: Standardized deviation = (40% - 20%)/15% =+1.333.

Probability of 40 percent or more return = (approx.) 9 %

50 percent: Standardized deviation = (50% - 20%)/15% =+2.00.

Probability of 50 percent or more return = 2.28 percent.