Question

Consider the following information:

Standard Deviation                    Beta

Security C                   20%                                     1.25

Security K                   30%                                     0.95

Which security should have the higher expected return? Explain in full. Please make sure to also explain which security has more total risk, and which security has more systematic risk within your answer.

Answer 1

SECURITY "C" HAS HIGHER BETA (1.25) IN COMPARISON TO SECURITY "K" (0..95), WHICH INDICATES THAT SECURITY "C" WILL CHANGE BY 1.25% AND SECURITY "K" WILL CHANGE BY 0.95% WITH RESPECT TO 1% CHANGE IN MARKET(INDEX)

SO SECURITY "C" WILL HAVE HIGHER RETURN  

THE STANDARD DEVIATION SHOWS WHO HAS MORE TOTAL RISK .

SECURITY "K" HAS HIGHER SD THAN SECURITY "C"

SO TOTAL RISK IS HIGHER FOR SECURITY "K"

SYSTEMATIC RISK IS DEFINED AS = (BETA)²(SD MARKET)²

NOW AS BETA IS HIGHER FOR SECURITY "C",

SECURITY "C" HAS HIGHER SYSTEMATIC RISK

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