Question

eBook Problem Walk-Through Stocks A and B have the following probability distributions of expected future returns: Probability 0.1 (9%) 0.1 0.5 14 0.2 (30%) 21 39 a. Calculate the expected rate of return, Te, for Stock B (TA - 13.60%.) Do not round intermediate calculations. Round your answer to two decimal places. 17.2 ♡ b. Calculate the standard deviation of expected returns, OA, for Stock A (OB = 18.30%.) Do not round intermediate calculations. Round your answer to two decimal places 10.12 Now calculate the coefficient of variation for Stock B. Do not round intermediate calculations. Round your answer to two decimal places. 1.06 g Is it possible that most investors might regard Stock B as being less risky than Stock A? 1. If Stock B is less highly correlated with the market than A, then it might have a higher beta than Stock A, and hence be more risky in a portfolio sense. II. If Stock B is more highly correlated with the market than A then it might have a higher beta than Stock A, and hence be less risky in a portfolio sense. 111. If Stock B is more highly correlated with the market than A then it might have a lower beta than Stock A, and hence be less nsky in a portfolio sense. IV. If Stock B is more highly correlated with the market than A, then it might have the same beta as Stock A, and hence be just as nisky in a portfolio sense. V. If Stock B is less highly correlated with the market than A then it might have a lower beta than Stock A, and hence be less risky in a portfolio sense. C. Assume the free rate s 4.5%. What are the Sharperation for Stocks A and 87 Do not round Intermediate calculations. Round your answers to four decal places Stock A: 7442 3 Stock B: 1.0640 Are these chictions consistent with the information obtained from the coefficient of variation calculations in Part 1. In a BRATA R Rahman.ca 3:17 PM

why this is happening?

Answer 1

b.

the simple explanation to this is,

high correlation In the market means high beta , and high beta means high risk

• because , high correlation means that with change in market the stock changes because there is great correlation between them,
• and as the correlation is high that means it is positive and have effect due to changes in market so high beta
• and high beta means that the stock is more volatile and so risky

so here these all conditions match in the V statement

V. when the stock is less correlated than A- less beta than A- less risky than A

So the answer is V.

c. Sharpe ratio= (Portfolio return – risk free return)/ standard deviation

A:

Portfolio return=13.60

Risk free return= 4.5%

Std deviation =10.12%

Sharpe ratio= (13.60-4.5)/10.12

= 0.899 or 0.90

B:

Portfolio return=17.2

Risk free return= 4.5%

Std deviation =18.30%

Sharpe ratio= (17.2-4.5)/18.30

= 0.694