Question

4. You are considering investing in Stock A which has an expected return of 15% and a Beta of 1.5 or in Stock B which has an expected return of 8% and a Beta of 0.5. The risk-free rate is 4%. Which investment would you prefer? Show Calculation (3 pts)

Answer 1

Given about stock A

Expected return Ra = 15%

Beta Ba = 1.5

Given about stock B

Expected return Rb = 8%

Beta Bb = 0.5

risk free rate Rf = 4%

So, calculating Treynor ratio to company two stock

Treynor ratio = (R - Rf)/Beta

So, Treynor ratio of A is (15 - 4/)1.5 = 7.33

Treynor ratio for B = (8 - 4)/0.5 = 8

Tyernor ratio is risk-adjusted measurement of return based on systematic risk

So, higher the ratio, better the stock.

So, Stock B is better for investment and so it will be preferred.