Question

Excel Online Structured Activity: Evaluating risk and return Stock X has a 10.0% expected return, a beta coeficient of 0.9, and a 30% standard deviation of expected returns. Stock Y has a 12.0% expected return, beta coefficient of 1.1, and a 20.0% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below. Open spreadsheet a. Calculate each stock's coefficient of variation. Round your answers to two decimal places. Do not round Intermediate calculations. CV- CV- b. Which stock is riskler for a diversified Investor? 1. For diversified investors the relevant risk is measured by beta. Therefore, the stock with the lower beta is more risky. Stock X has the lower beta so it is more risky than Stock Y. II. For diversified investors the relevant risk is measured by standard deviation of expected returns. Therefore, the stock with the lower standard deviation of expected returns is more risky, Stock Y has the lower standard deviation soft is more risky than Stock X. III. For diversified investors the relevant risk is measured by beta. Therefore, the stock with the higher beta is less risky, Stock Y has the higher beta so it is less risky than Stock X. IV. For diversified investors the relevant risk is measured by beta. Therefore, the stock with the higher beta is more risky. Stock Y has the higher beta so it is more risky than Stock X. V. For diversified investors the relevant risk is measured by standard deviation of expected returns. Therefore, the stock with the higher standard deviation of expected returns is more risky. Stock X has the higher standard deviation so it is more risky than Stock Y.

Answer 1

Ans:- (a) Coefficient of variation is given by ( Standard Deviation / Expected Return )

Coefficient of variation of stock x will be (30% / 10% = 3).

Coefficient of variation of stock y will be ( 20% / 12% = 1.67)

(b) The correct Option is IV. For a diversified investor, the relevant risk is measured by beta. Therefore the stock with a higher beta is more risky. Stock Y has the higher beta so it is more risky than stock X.

(c) The required return of stocks will be given by Risk-free rate + beta * Market Risk Premium.

Required return for x = 6% + 0.9 * 5% =10.5%

Required return for y = 6% + 1.1 * 5% = 11.5%.

Stock X required return is more than the expected return, whereas the Stock Ys required return is less than the expected return, therefore, Stock Y is more attractive to a diversified investor because its required return is less than the expected return.

(d) If $7500 invested in stock x and $3000 invested in stock y then the required return will be

=( $7500 * 10.5% + $3000 * 11.5% ) / ( $7500 + $3000) = 10.79%.

(e) If the new risk premium is 6% then the then the required return will be

Required return for stock X = 6% + 0.9 * 6% =11.4%

Required return for stock Y = 6% + 1.1 * 6% = 12.6%.

Increase in return of stock x is ( 11.4% - 10.5% = 0.9%) and increase in return on stock y is (12.6% - 11.5% =1.1%). Therefore stock y has higher increase in required return.

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