Question

EVALUATING RISK AND RETURN Stock X has a 10% expected return, a beta coefficienta 0.9. and a 35.0 standard deviation of expected returns. Stock Y has a 12.5% expected return a beta coefficient of 1.2, and a 25% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%. al Calculate each stock's coefficient of variation. Which stock is riskier for a diversified investor? Calculate each stock's required rate of return. d. On the basis of the two stocks' expected and required returns, which stock would be more attractive to a diversified investor? Calculate the required return of a portfolio that has $7500 invested in Stock X and AJ If the market risk premium increased to 6%, which of the two stocks would have the larger increase in its required return?

Answer 1

a)Coefficient of Variation =Standard Deviation /Expected Return

Coefficient of Variation(x)=35/10=3.5

Coefficient of Variation(y)=25/12.5=2.0

b)Y is riskier as it has a beta of 1.2 more than 1

c) req rate of return= riskfree rate+beta(markt return-risk free rate) or riskfree rate+beta(markt risk premium)

for(x)=0.06+0.9(0.05)=0.105=10.5%

for(y)=0.06+1.2(0.05)=0.120=12 %

d)expected and requiered return both are large for Y so Y is better

e)7500in x and 2500in y so total portfolio is 7500+2500=10,000

so x weight in portfolio is 75% and for y it is 25%

req return of portfolio=w1r1+w2r2=0.75*0.069+0.25*0.072=0.05175+0.018=0.06975=6.975%

f) now market risk premim is 6%

req rate of return= riskfree rate+beta(markt return-risk free rate) or riskfree rate+beta(markt risk premium)

for(x)=0.06+0.9(0.06)=0.114=11.4%

for(y)=0.06+1.2(0.06)=0.132=13.2%

now fo x increase to 11.4 from 10.5 that is of 0.9

now for y increase to 13.2 from 12.0 that is of 1.2

means increase in Y is more

2nd part) as it is a constatnt growth model

we need to calculare req return =riskfree rate+beta(markt risk premium)=0.049+0.9*0.05=0.094=9.4%

so price will be =P3 =p0(1+g) power 3

g=4.5%

P0=46

p3=52.49