1. Consider two available stocks: A and B. Suppose that the rates of return on both stocks, RA and RB, are random variables with the following probability distribution functions:
• _P(RA = x) = 1/4; for x = -1, 0, 1, 2
• _P(RB = x) = (x + 5)/36; for x = -4, -3, -2, -1, 0, 1, 2, 3
a. Calculate the expected value of both rates of return.
b. Calculate the standard deviation of both rates of return. Hint: By definition, var(X) = E(X2) - (E(X))2 = E[(X - E(X))2].
c. Which stock has a higher stand-alone risk? Explain.
d. Which stock (if either) is a better investment? Explain.