The risk of a portfolio of financial assets is sometimes called investment risk. In general, investment risk is typically measured by computing the variance or standard deviation of the probability distribution that describes the decision maker's potential outcomes (gains or losses). The greater the variation in potential outcomes, the greater the uncertainty faced by the decision maker; the smaller the variation in potential outcomes, the more predictable the decision maker's gains or losses. The two discrete probability distributions given in the next table were developed from historical data. They describe the potential total physical damage losses next year to the fleets of delivery trucks of two different firms.

a. Verify that both firms have the same expected total physical damage loss.
b. Compute the standard deviation of each probability distribution and determine which firm faces the greater risk of physical damage to its fleet next year.

Transcribed Image Text:

Firm A Firm B Loss Next Year Probability Loss Next Year Probability 0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500 5,000 01 01 01 02 .35 30 01 02 200 700 1.200 1.700 2.200 2.700 3,200 3,700 4,200 4,700 15 30 .30 .15 .02 02 01 01 01 01