Stock X has a 10% expected return, a beta coefficient of 0.9, and a 35% standard deviation of expected returns. Stock Y has a 12.5% expected return, a beta coefficient of 1.2, and a 25% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%.
a. Calculate each stock’s coefficient of variation.
b. Which stock is riskier for a diversified investor?
c. Calculate each stock’s required rate of return.
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 $7,500 invested in Stock X and $2,500 invested in Stock Y.
f. If the market risk premium increased to 6%, which of the two stocks would have the larger increase in its required return?
(Please make work neat and understandable)
Coefficient of variation=Standard deviation/Expected return
The relevant measure of risk for a well diversified investor is beta. Higher beta means higher risk. Hence, Stock Y is riskier.
required return=risk free rate+beta*market risk premium
Stock Y as expected return is more than required return
Stock Y as it has higher beta
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