Question

Consider the following information about Stocks I and II

Consider the following information on Stocks I and Il: Probability of State of Economy Rate of Return if State Occurs Stock Stock II State of Economy Recession Normal Irrational exuberance 20 55 25 02 32 18 -20 12 40 The market risk premium is 7 percent, and the risk-free rate is 4 percent Requirement 1: (a) Calculate the beta and standard deviation of Stock I. (Do not round intermediate calculations. Enter the standard deviation as a percentage. Round your answers to 2 decimal places (e.g., 32.16).) Stock Beta Standard deviation % (b) Calculate the beta and standard deviation of Stock II. (Do not round intermediate calculations. Enter the standard deviation as a percentage. Round your answers to 2 decimal places (e.g., 32.16).) Stock I Beta Standard deviation % Requirement 2: (a) Which stock has the most systematic risk? (Click to select) (b)Which one has the most unsystematic risk? (Click to select) (c) Which stock is "riskier"? (Click to select)

Answer 1

Expected Return (R)= Sum of (P*X) Risk = Sum of PIX-R) STOCKI State of Economy Recession Normal Irrational Exuberance Probability (P) Return (X) P*X 0.2 0.55 0.25 18 P(X-R) 0. 4 84.05 17.6) 49.6375 4.5 5.0625 22.5 138.75 Standard Deviation = 11.78 Return = Risk Free Return +(Beta * Market Risk Premiun 22.5 = 4 +(Beta *7) Beta = 2.64 STOCK II State of Economy Recession Normal Irrational Exuberance Probability (P) Return (X) P*X 0.2 -201 0.55 0.25| 40 PIX-R) -4 361.25 6.6 60.6375 10 76.5625 12.6) 498.45 Standard Deviation = 22.33 Return = Risk Free Return +(Beta * Market Risk Premiun 12.6 = 4 +(Beta7) Beta = 1.23

Requirement 1 :

(a) Beta of Stock I = 2.64

Standard Deviation of Stock I = 11.78%

(b) Beta of Stock II = 1.23

Standard Deviation of Stock II = 22.33%

Requirement 2:

(a) Systematic Risk is captured by Beta of Stock. Stock I has higher systematic risk.

(b) Unsystematic risk is captured by standard deviation. Stock II has higher unsystematic risk.

(c) Stock II is riskier