Question

Consider the following information:

                                   

Standard Deviation                Beta

            Security T                   20%                            1.90

            Security K                  30%                            1.90

1. Which security has more total risk? (5 points)
2. Which security has more systematic risk? (5 points)
3. Which security should have the higher expected return? (5 points)
4. What does the total risk consist of? What kind of risk is eliminated with portfolio diversification? (5 points)

Answer 1

1.
Security K as evident from higher standard deviation because higher standard deviation means higher total risk

2.
Both have same systematic risk as beta is same. Beta measures systematic risk and higher beta means higher systematic risk

3.
Both should have same expected returns as only systematic risk is rewarded and both have same systematic risk

4.
Total risk consists of systematic/market/non-diversifiable and unsystematic/unique/firm specific/diversifiable risk

Unsystematic/unique/firm specific/diversifiable risk is eliminated with diversification