Question

S13-26 Systematic versus Unsystematic Risk (LO3] Consider the following information about Stocks I and II: Rate of Return If State Occurs Probability of State of Economy .15 Stock Stock 11 --23 State of Economy Recession Normal Irrational exuberance .03 .20 .70 .09 .15 .08 .43 The market risk premium is 7 percent, and the risk-free rate is 3.5 percent. (Round your answers to 2 decimal places, e.g., 32.16.) The standard deviation on Stock I's return is deviation on Stock Il's return is stock's systematic risk/beta, Stock percent, and the Stock I beta is percent, and the Stock Il beta is is riskier. . The standard . Therefore, based on the

Answer 1

deviation Stock State of economy Returns probability deviation^2 deviation Return- 15.65% 2x probability Recession 0.03 Normal 1 0.20 Irrational exuberance 0.08 Expected return 0.15 0.70 0.15 Expected return (Return x probability) 0.45% 14.00% 1.20% 15.65% -12.65000% 4.35000% -7.65000% 1.60023% 0.18923% 0.58523% 0.24003% 0.13246% 0.08778% Variance Standard deviation = variance10.5 105 0.00460 6.78% Expected return = 15.65%= Beta = Stock II State of economy risk free rate + beta x market risk premium 3.5% + beta x 7% 1.74 deviation Returns probability deviation^2 deviation^2x probability Return-9.3% Recession -0.23 Normal 0.09 Irrational exuberance 0.43 Expected return 0.15 0.70 0.15 Expected return (Return x probability) -3.45% 6.30% 6.45% 9.30% -32.30000% -0.30000% 33.70000% 10.43290% 0.00090% 11.35690% 1.56494% 0.00063% 1.70354% 1 Variance Standard deviation = variance10.5 0.03269 18.08% Expected return = risk free rate + beta x market risk premium 9.30% = 3.5% + beta x 7% Beta = 0.83 Stock I is more riskier