Question

Consider the following information on Stocks I and II:

State of Economy	Probability of State of Economy	Rate of Return if State Occurs
		Stock I	Stock II
Recession	.25	.04	−.22
Normal	.60	.22	.15
Irrational exuberance	.15	.16	.45

The market risk premium is 7 percent, and the risk-free rate is 4 percent.

a.	Calculate the beta of each stock. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
b.	Calculate the standard deviation of each stock. (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
c.	Which stock has the most systematic risk?
d.	Which one has the most unsystematic risk?
e.	Which stock is “riskier”?

Answer 1

D3 D3 : x + =A3-$C$6 3x B C D E F 1 Stock Return (r) 4 (r-u)^ 2 am 3 Probability | Expecte return [(P(r)] [rxP(r) ] Ir -u 0. 251 .00% -12.60% 0.60 13.20% 5.40% 0.15 2.40% -0.60% 16.60% .0% 22.0% 16.0% P 0.016 0.003 0.000 (r)x(r-u)^2 0.004 0.002 0.000 4 5 6 Expected return 0.006 Variance (012) Standard deviation (0) 7.57% 0 1.80 =(16.6%-4%)/7% 9 Beta of the stock 10 11 Stock II 12 Return (r) 13 14 15 16 Expected return 17 -22% 15% 45% Probability Expecte return [(P(r)] [rxP(r)=u] r-μ 0.25/ -5.50% -32.25% 0.60 9.00% 4.75% 0.15 6.75% 34.75% 10.25% (r-u)^2 10.40% 0.23% 12.08% P(r)x(r-u)^2 2.60% 0.14% 1.81% Variance (012) | 0.045469 Standard deviation (0)| 21.32% CO 19 Beta of the stock II 0.89 = (10.25%-4%)/7% 20 21 Stock I has higher systematic risk. 22 Stock II has higher unsystematic risk. 23 Stock I is riskier

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