Question

Consider the following information on Stocks I and II:

		Rate of Return If State Occurs
	Probability of
State of Economy	State of Economy	Stock I	Stock II
Recession	.35	.04	-.20
Normal	.30	.27	.14
Irrational exuberance	.35	.21	.37

The market risk premium is 10 percent, and the risk-free rate is 4 percent.

1-a.	What is the beta of each stock? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

	Beta
Stock I
Stock II

1-b.

Which stock has the most systematic risk?

	Stock I
	Stock II

2-a.	What is the standard deviation of each stock? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places. Omit the "%" sign in your response.)

	Standard Deviation
Stock I	%
Stock II	%

2-b.

Which one has the most unsystematic risk?

	Stock I
	Stock II

3.

Which stock is “riskier”?

	Stock I
	Stock II

Answer 1

Rate of return for stock1

=probability*stock return

=0.35*.04+.30*.27 + .35*0.21

=16.85%

Rate of return for stock2

=probability*stock return

=0.35*-.2+.30*.14 + .35*0.37

=10.15%

Stock1

Using CAPM model

rate of return =rf+b*Market risk premium

16.85 = 4+b*10

b= 1.29

Stock2

Using CAPM model

rate of return =rf+b*Market risk premium

10.15 = 4+b*10

b= 0.62

part b)

stock 1 beta is higher so it has more systematic risk

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