Question

Stock X has a 9.0% expected return, a beta coefficient of 0.7, and a 35% standard deviation of expected returns. Stock Y has a 13.0% expected return, a beta coefficient of 1.3, and a 25% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%.

1. Calculate each stock's coefficient of variation. Do not round intermediate calculations. Round your answers to two decimal places.

   CV_x =

   CV_y =

2. Which stock is riskier for a diversified investor?
   1. For diversified investors the relevant risk is measured by standard deviation of expected returns. Therefore, the stock with the lower standard deviation of expected returns is riskier. Stock Y has the lower standard deviation so it is riskier than Stock X.
   2. For diversified investors the relevant risk is measured by beta. Therefore, the stock with the higher beta is less risky. Stock Y has the higher beta so it is less risky than Stock X.
   3. For diversified investors the relevant risk is measured by beta. Therefore, the stock with the higher beta is riskier. Stock Y has the higher beta so it is riskier than Stock X.
   4. For diversified investors the relevant risk is measured by standard deviation of expected returns. Therefore, the stock with the higher standard deviation of expected returns is riskier. Stock X has the higher standard deviation so it is riskier than Stock Y.
   5. For diversified investors the relevant risk is measured by beta. Therefore, the stock with the lower beta is riskier. Stock X has the lower beta so it is riskier than Stock Y.

   -Select-

3. Calculate each stock's required rate of return. Round your answers to one decimal place.

   r_x =   %

   r_y =   %

4. On the basis of the two stocks' expected and required returns, which stock would be more attractive to a diversified investor?

   -Select-

5. Calculate the required return of a portfolio that has $9,000 invested in Stock X and $3,000 invested in Stock Y. Do not round intermediate calculations. Round your answer to two decimal places.

   r_p =   %

6. If the market risk premium increased to 6%, which of the two stocks would have the larger increase in its required return?

   -Select- Stock X or Stock Y I

Answer 1

a. CVx =Standard Deviation/Expected Return =35%/9%=3.89
CVy =Standard Deviation/Expected Return =25%/13%=1.92

b. Option III is correct option. Higher the beta higher the risk.

c. Rx =Risk free rate+beta*(Market Return-Risk free rate)=6%+0.7*5%=9.5%
Ry =Risk free rate+beta*(Market Return-Risk free rate)=6%+1.3*5%=12.50%

d. Stock Y expected return is greater than required rate(13% >12.50%)(Hence Stock Y is more attractive)

e. the required rate of portfolio =9000/12000*9.5%+3000/12000*12.50% =10.25%

f. Required rate of Stock Y will increase more because beta of stock Y is 1.3