Question

Ch 08: End-of-Chapter Problems - Risk and Rates of Return a. Calculate each stock's coeffident of variation. Round your answers to twe decimal places. Do not round intermediate calculations. CV.- b. Which stock is riskier for a diversified investor? I. 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. II. 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. III. 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. IV. 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 so it is more risky than Stock X. V. 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. Select c. Calculate each stock's required rate of return. Round your answers to two decimal places. % d. On the basis of the two stocks' expected and required returns, which stock would be more attractive to a diversified investor? Select e. Calculate the required return of a portfolio that has $7,50d invested in Stock X and $4,000 invested in Stock Y. Do not round intermediate calculations. Round your answer to two decimal places. . If the market risk premium increased to 6%, which of the two stocks would have the larger increase in its required retur? Select

Answer 1

a]

CV = standard deviation / expected return

X = 40% / 10.5% = 3.81

Y = 30% / 12% = 2.50

b]

For a diversified investor, the relevant risk measure is beta. Total risk is measured by standard deviation, and consists of both systematic and unsystematic risk. For a diversified investor, the systematic risk (beta) is close to 1. The unsystematic risk has been diversified away. Hence, the appropriate risk measure for a diversified investor is the beta of the individual stock.

Higher the beta, higher the systematic risk of the stock.

Hence, the answer is I - Stock Y has higher beta, so it is more risky than Stock X

c]

required return = risk free rate + (beta * market risk premium)

X = 6% + (1.0 * 5%) = 11.00%

Y = 6% + (1.1 * 5%) = 11.50%

d]

Stock Y is more attractive as its expected return is higher than its required return