Question

EVALUATING RISK AND RETURN Stock X has a 10.0% expected return, a beta coefficient of 0.9, and a 35% standard deviation of expected returns. Stock Y has a 12.0% expected return, a beta coefficient of 1.1, and a 25.0% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%. 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 diversifled investor? 1. 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. II. 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 III. 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. IV. 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. V. 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 -Select- c. Calculate each stock's required rate of retum. Round your answers to two decimal places. Ty -Select- d. On the basis of the two stocks' expected and required returns, which stock would be more attractive to a diversified investor? e. Calculate the required return of a portfolio that has $7,000 invested in Stock X and $3,500 invested in Stock Y. Do not round intermediate calculations. Round your answer to two decimal places р f. If the market risk premium increased to 6%, which of the two stocks would have the larger increase in its required return? -Select-

Answer 1

e) a) risk-free rate market risk premium 6% 5% Amount invested in Stock X Amount invested in Stock Y Total investment amount $7,000 3,500) $10,500 Stock х Y Expected return Beta coefficient Standard deviation 10.0% 0.9 35% 12.0% 1.1 25.00% weight of stock = amount invested in stock/ total investment amount weight of stock w 0.67 W 0.33 Stock's coefficient of variation - Standard deviation / Expected return Coefficient of Variation (CV) CV, 3.50 CVy 2.08 required return of a portfolio = (wx*r«) + (wy *ry) required return of a portfolio 10.83% f) Stock Y would have larger increase in its required return because beta of Stock Y is greter than that of Stock X. b) For diverdified 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. Answer: (V) c) Stock's required rate of return = risk-free rate +(beta * market risk premium) Required rate of return [r] 10.50% ry 11.50% d) Stock Y would be more attractive to a diversified investor because expected return is greater than the required rate of return.