Question

12.5% O 15.8% 17.2% Question 4 The expected returns for Stocks A, B, C, D, and E are 7 percent, 10 percent, 12 percent, 25 percent, and 18 percent, respectively. The corresponding standard deviations for these stocks are 12 percent, 18 percent, 15 percent, 23 percent, and 15 percent, respectively. Which one of the securities should a risk-averse investor purchase if the investment will be held in isolation (by itself? ОА Ов oc OD 5 pts Question 5 The market portfolio contains only unsystematic risk, therefore the market risk premium represents the return that investors require to be compensated for al amount of relevant or systematis, risk

Answer 1

Solution:

We shall use the co-efficient of variation to measure the risk level of the five stocks.

The coefficient of variation is a measure of risk per unit of return or reward.

The formula for calculating the coefficient of variation is

= Standard Deviation / Expected Return

Thus the

a. Coefficient of variation for Stock A

As per the Information given in the question we have

Expected Return = 7 % and Standard Deviation = 12 %

Applying the above values in the formula we have :

= 12 % / 7 % = 1.7143

Coefficient of variation of Stock A = 1.7143

b. Coefficient of variation for Stock B

As per the Information given in the question we have

Expected Return = 10 % and Standard Deviation = 18 %

Applying the above values in the formula we have :

= 18 % / 10 % = 1.8000

Coefficient of variation of Stock B = 1.8000

c. Coefficient of variation for Stock C

As per the Information given in the question we have

Expected Return = 12 % and Standard Deviation = 15 %

Applying the above values in the formula we have :

= 15 % / 12 % = 1.2500

Coefficient of variation of Stock C = 1.2500

d. Coefficient of variation for Stock D

As per the Information given in the question we have

Expected Return = 25 % and Standard Deviation = 23 %

Applying the above values in the formula we have :

= 23 % / 25 % = 0.9200

Coefficient of variation of Stock D = 0.9200

e. Coefficient of variation for Stock E

As per the Information given in the question we have

Expected Return = 18 % and Standard Deviation = 15 %

Applying the above values in the formula we have :

= 15 % / 18 % = 0.8333

Coefficient of variation of Stock E = 0.8333

We can see that, Stock E has the lowest Co efficient of variation i.e., Lowest risk per unit of reward.

Thus a risk averse investor should purchase Stock E.

The solution is Option 5 = E