Stock ABC has an expected return of 12% and a standard deviation of 48%. Which of the following stocks dominate Stock ABC?
A) Expected return = 14%; Standard deviation = 53%
B) Expected return = 10%; Standard deviation = 31%
C) Expected return = 13%; Standard deviation = 45%
D) Expected return = 11%; Standard deviation = 52%
E) None of these stocks dominate stock 'ABC'.

Question

Quizplus · Accepted Answer

In order to determine which stock dominates Stock ABC, we need to look at the risk-return tradeoff, and in particular, the Sharpe Ratio (which measures the excess return per unit of risk, i.e. the ratio of expected return to standard deviation).

Stock ABC has a Sharpe Ratio of 12%/48% = 0.25

For each of the other stocks, we calculate the Sharpe Ratio as follows:

A) 14%/53% = 0.26
B) 10%/31% = 0.32
C) 13%/45% = 0.29
D) 11%/52% = 0.21

Therefore, Stock B has the highest Sharpe Ratio, which means it dominates Stock ABC in terms of risk-adjusted performance.

Stock ABC Has an Expected Return of 12% and a Standard