Question

2. A financial analyst measures the monthly returns of two stocks (A and B) over a twenty year period. Over that time period, stock A had an average return of 11% (per year) with a standard deviation of 20%. Over that same period, stock B had an average return of 13% with a standard deviation of 17%. The analyst estimates the CAPM for both stocks. The results are below: Stock A: SUMMARY OUTPUT Regression Statistics Multiple R 0.734020234 R Square 0.538785703 Adjusted R Square 0.536847828 Standard Error 3.134961537 Observations 240 ANOVA df 1 Regression Residual Total SS MS F Significance F 2732.465536 2732.465536 278.0291037.08566E-42 2339.060154 9.82798384 5071.52569 238 239 Intercept Mkt-RF Coefficients 0.948895353 0.755908016 Standard Error t Stat P-value 0.202697319 4.207955658 0.00726115 0.045333977 16.67420473 7.0857E-42 Lower 95% Upper 95% 0.549585378 1.348205328 0.666600918 0.845215113 Stock B:

Answer 1

Risk Premium = (Rm – Rrf)

The CAPM formula is used for calculating the expected returns of an asset. It is based on the idea of systematic risk or non-diversifiable risk and that investors need to be compensated for it in the form of a risk premium. A risk premium is a rate of return greater than the risk-free rate.
Expected return = Risk Free Rate + [Beta x Market Return Premium].
Therefore calculating from above given information, stock B seems to have more diversified risk