Question

Consider the following information on Stocks I and II:

				Rate of Return if State Occurs
State of	Probability of
Economy	State of Economy			Stock I			Stock II
Recession		.28			.05		−	.20
Normal		.53			.17			.07
Irrational exuberance		.19			.06			.40

The market risk premium is 8 percent, and the risk-free rate is 2 percent. (Do not round intermediate calculations. Enter your standard deviation answers as a percent rounded to 2 decimal places (e.g., 32.16). Round your beta answers to 2 decimal places (e.g., 32.16).)

  

The standard deviation on Stock I's expected return is  percent, and the Stock I beta is  . The standard deviation on Stock II's expected return is  percent, and the Stock II beta is  . Therefore, Stock  (Click to select)  I  II  is "riskier"

Answer 1

Expected return of Stock I=0.28*0.05+0.53*0.17+0.19*0.06=0.1155

Standard deviation of Stock I=sqrt(0.28*(0.05-0.1155)^2+0.53*(0.17-0.1155)^2+0.19*(0.06-0.1155)^2)=0.057971976

Beta of Stock I=(11.55%-2%)/8%=1.19375

Expected return of Stock II=0.28*(-0.20)+0.53*0.07+0.19*0.40=0.0571

Standard deviation of Stock II=sqrt(0.28*(-0.20-0.0571)^2+0.53*(0.07-0.0571)^2+0.19*(0.40-0.0571)^2)=0.202327927

Beta of Stock II=(5.71%-2%)/8%=0.46375

The standard deviation on Stock I's expected return is 5.7971976 percent, and the Stock I beta is 1.19375

The standard deviation on Stock II's expected return is 20.2327927 percent, and the Stock II beta is 0.46375
Therefore, Stock II is "riskier"