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You have a friend who claims that because Microsoft has a higher standard deviation than Exxon,...

You have a friend who claims that because Microsoft has a higher standard deviation than Exxon, it must have a higher cost of equity as well. Briefly explain why this is an incorrect statement.

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Answer #1

Required rate of Cost of Equity = Rf + beta ( Rm - Rf )

Rf = Risk free ret
Rm = Market ret
Rm - Rf = Risk Premium
Beta = Systematic Risk

SD specifies Total Risk, which consists Systematic Risk and Unsystematic risk

Systematic risk is Market risk and can't be reduced. where as Unsystematic risk is organization specific risk and can be reduced through proper diversification strategy.

Hence we need to consider the Systematic risk rather than total risk while decideing COst of equity.

Pls do rate, if the answer is correct and comment, if any further assistance is required.

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