Question

Stocks A and B have the following probability distributions of expected future returns: Probability A B...

Stocks A and B have the following probability distributions of expected future returns:

Probability A B
0.1 (8%) (36%)
0.3 3 0
0.3 12 20
0.2 18 25
0.1 33 48
  1. Calculate the expected rate of return, rB, for Stock B (rA = 10.60%.) Do not round intermediate calculations. Round your answer to two decimal places.
    %

  2. Calculate the standard deviation of expected returns, σA, for Stock A (σB = 21.36%.) Do not round intermediate calculations. Round your answer to two decimal places.
    %

  3. Now calculate the coefficient of variation for Stock B. Round your answer to two decimal places.

  4. Is it possible that most investors might regard Stock B as being less risky than Stock A?  

    1. If Stock B is more highly correlated with the market than A, then it might have a higher beta than Stock A, and hence be less risky in a portfolio sense.
    2. If Stock B is more highly correlated with the market than A, then it might have a lower beta than Stock A, and hence be less risky in a portfolio sense.
    3. If Stock B is more highly correlated with the market than A, then it might have the same beta as Stock A, and hence be just as risky in a portfolio sense.
    4. If Stock B is less highly correlated with the market than A, then it might have a lower beta than Stock A, and hence be less risky in a portfolio sense.
    5. If Stock B is less highly correlated with the market than A, then it might have a higher beta than Stock A, and hence be more risky in a portfolio sense.

Homework Answers

Answer #1
a)
Probability B Expected Return= Prob. X Return
0.1 -36.00% -3.60%
0.3 0.00% 0.00%
0.3 20.00% 6.00%
0.2 25.00% 5.00%
0.1 48.00% 4.80%
Expected Return 12.20%
b)
Probability A Return - Expected Return (10.60%) (Return - Expected Return)^2 (Return - Expected Return)^2 X probability
0.1 -8.00% -18.60% 0.034596 0.0034596
0.3 3.00% -7.60% 0.005776 0.0017328
0.3 12.00% 1.40% 0.000196 0.0000588
0.2 18.00% 7.40% 0.005476 0.0010952
0.1 33.00% 22.40% 0.050176 0.0050176
Variance 0.011364
Standard Deviation=sqrt(variance) 10.66%
c)
Coefficient of variation = SD/Expected Return
Coefficient of variation of B = 21.36%/12.20% 1.75
d)
If Stock B is less highly correlated with the market than A, then it might have a lower beta than Stock A, and hence be less risky in a portfolio sense.
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