Question

Please show work that is not on excel please. Thank you.

Consider the following information 30. Systematic versus Unsystematic Risk. on Stocks I and II: Probability of State of Economy State of Rate of Return If State Occurs Economy Stock I Stock ll Recession 25 -.20 .02 Normal .12 60 .32 Irrational exuberance .40 .15 .18 00B 0 The market risk premium is 7 percent, and the risk-free rate is 4 percent. Which stock has the most systematic risk? Which one has the most unsystematic risk? Which stock is "riskier"? Explain.

Answer 1

a. Return of stock I = 22.4%
Return of stock II = 8.2%

b. Standard deviation of stock I = 12.73%
STANDARD DEVIATION OF STOCK II = 18.95%

c. 1. Capital Asset pricing model:

As per CAPM model:
Re= Rf+(Rm-Rf)B

Re= required rate of return. 22.4%
Rf= Risk-free rate. 4%
Rm =Market Risk Premium. 7%
B = Beta, systematic risk. ?

22.4 = 4+(7-4)B
Beta (B) = 6.13 (Stock I)

2. Capital Asset pricing model:

As per CAPM model:
Re= Rf+(Rm-Rf)B

Re= required rate of return. 8.2%
Rf= Risk-free rate (nominal) = 4%
Rm =Market Risk Premium. 7%
B = Beta, systematic risk. ?

8.2= 4+(7-4) x B
Beta = 1.4 (Stock II)

D. A has the most systematic risk as its beta is higher.
B has most unsystematic risk because it's differential between standard deviation and systematic risk is higher.
B is more risker because it has a higher standard deviation.

let Stock I> A Stock II=B Retuen P A B PA PB 0-25 24.- 204. 0.25x2 0.25x=20 O.GO 32% 12% 0.60×32 0.60x12 0.15 18%. 40% 0.15x18 0,15x40 EPA-Ā EPB = B: 22.4% 8.2% 3 petuen Toral. Px (A - A)" 0-25 ( 2 - 22.4) 0.60 (32-224) ² 0.15 (18- 22-4)² EPCA-A) 3 van 162.24% TA = 12-73% Px (B-B) ² 0.25 (-20-8-2)² 0-601 12-8-292 0-15 ( 40-8-2) 2 E P(B-6) V-3359-167." B=18.95% Standard deviation