Question

A stock will provide a rate of return of either ?28% or 33%.

a.	If both possibilities are equally likely, calculate the stock's expected return and standard deviation. (Do not round intermediate calculations. Enter your answers as a percent rounded to 1 decimal place.)

Expected return	%
Standard deviation	%

b.	If Treasury bills yield 2.5% and investors believe that the stock offers a satisfactory expected return, what must the market risk of the stock be? (Enter your answer as a whole percent.)

Market risk

%

Answer 1

A.

Expected Return is mathematically given by:

Hence, in our question,

Expected return of the stock = (50% * 28%) + (50% * 33%) = 14% + 16.5% = 30.5%

In order to calculate the standard devaition, we fill use the below mathematical relation

Hence, here is this question,

(Expected std devaition)² = 50% * (28% - 30.5%)² + 50% * (33% - 30.5%)²

(Expected Std deviation)² = 0.000625

Hence, Expected Std Devation = 2.5%

b. Market Risk =28%

Market risk of a stock is its excess expected return over the return provided by a T-Bill.

In our question T-bill yield = 2.5%

Expected return on stock is 30.5%

Excess market risk of stock = 30.5% - 2.5% = 28%