1. Measuring risk using realized data Aa Aa Returns earned over a given time period are called realized returns. Historical data on realized returns is often used to estimate future results. Analysts across companies use realized stock returns to estimate the risk of a stock. Consider the case of Happy Dog Soap Inc. (HDS): Five years of realized returns for HDS are given in the following table. Remember: 1. While HDS was started 40 years ago, its common stock has been publicly traded for the past 25 years. 2. The returns on its equity are calculated as arithmetic returns. 3. The historical returns for HDS for 2012 to 2015 are: 2012 2013 2014 2015 2016 Stock return 8.75% 5.95% 10.50% 14.70% 4.55% Given the preceding data, the average realized return on HDS's stock is 8.89% Based on economic conditions, you've compiled the following estimates of returns from HDS's stock and the probabilities associated with the economic condition for the next year: Market Condition Probability 0.20 0.35 0.45 Boom Normal Recession The standard deviation of returns for Happy Dog Soap's stock is HDS's (r₁) 35% 21% -28% If investors expect the average realized return from 2012 to 2016 on HDS's stock to continue into the future, its coefficient of variation (v) will be Suppose you need to invest $10,000 in Happy Dog Soap Inc. or another company called Robonomics Corp. You know that Robonomics Corp. has a coefficient of variation of 6.16, and you have calculated the coefficient of variation for HDS. To make your investment decision, you spend some time analyzing the situation. Based on your analysis, which of the following statements is true? Happy Dog Soap (HDS) Inc. is two times more risky than Robonomics Corp. Robonomics Corp. is two times more risky than Happy Dog Soap (HDS) Inc.

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1. Measuring risk using realized data
Aa Aa
Returns earned over a given time period are called realized returns. Historical data on realized returns is often used
to estimate future results. Analysts across companies use realized stock returns to estimate the risk of a stock.
Consider the case of Happy Dog Soap Inc. (HDS):
Five years of realized returns for HDS are given in the following table. Remember:
1. While HDS was started 40 years ago, its common stock has been publicly traded for the past 25
years.
2. The returns on its equity are calculated as arithmetic returns.
3. The historical returns for HDS for 2012 to 2015 are:
2012 2013
2014
Stock return 8.75% 5.95% 10.50% 14.70%
2015 2016
Given the preceding data, the average realized return on HDS's stock is 8.89%
Boom
Normal
Recession
Based on economic conditions, you've compiled the following estimates of returns from HDS's stock and the
probabilities associated with the economic condition for the next year:
Market Condition Probability HDS's (r;)
0.20
35%
0.35
21%
0.45
-28%
The standard deviation of returns for Happy Dog Soap's stock is
4.55%
If investors expect the average realized return from 2012 to 2016 on HDS's stock to continue into the future, its
coefficient of variation (v) will be
Suppose you need to invest $10,000 in Happy Dog Soap Inc. or another company called Robonomics Corp. You know
that Robonomics Corp. has a coefficient of variation of 6.16, and you have calculated the coefficient of variation for
HDS. To make your investment decision, you spend some time analyzing the situation. Based on your analysis, which
of the following statements is true?
Happy Dog Soap (HDS) Inc. is two times more risky than Robonomics Corp.
Robonomics Corp. is two times more risky than Happy Dog Soap (HDS) Inc.
Transcribed Image Text:1. Measuring risk using realized data Aa Aa Returns earned over a given time period are called realized returns. Historical data on realized returns is often used to estimate future results. Analysts across companies use realized stock returns to estimate the risk of a stock. Consider the case of Happy Dog Soap Inc. (HDS): Five years of realized returns for HDS are given in the following table. Remember: 1. While HDS was started 40 years ago, its common stock has been publicly traded for the past 25 years. 2. The returns on its equity are calculated as arithmetic returns. 3. The historical returns for HDS for 2012 to 2015 are: 2012 2013 2014 Stock return 8.75% 5.95% 10.50% 14.70% 2015 2016 Given the preceding data, the average realized return on HDS's stock is 8.89% Boom Normal Recession Based on economic conditions, you've compiled the following estimates of returns from HDS's stock and the probabilities associated with the economic condition for the next year: Market Condition Probability HDS's (r;) 0.20 35% 0.35 21% 0.45 -28% The standard deviation of returns for Happy Dog Soap's stock is 4.55% If investors expect the average realized return from 2012 to 2016 on HDS's stock to continue into the future, its coefficient of variation (v) will be Suppose you need to invest $10,000 in Happy Dog Soap Inc. or another company called Robonomics Corp. You know that Robonomics Corp. has a coefficient of variation of 6.16, and you have calculated the coefficient of variation for HDS. To make your investment decision, you spend some time analyzing the situation. Based on your analysis, which of the following statements is true? Happy Dog Soap (HDS) Inc. is two times more risky than Robonomics Corp. Robonomics Corp. is two times more risky than Happy Dog Soap (HDS) Inc.
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