Question

Assume that the risk-free rate rf is equal to 2%, the market expected return is equal to 10%. Stock RGB has a volatility of 15% and a beta of 1.2. Stock SHC has a volatility of 25% and a beta of 0.7. Please mark the only FALSE statement:

	a.	the expected return of RGB is equal to 11.6%
	b.	the expected return of SHC is equal to 7.6%
	c.	SHC stock has more market risk than RGB
	d.	SHC stock is riskier than RGB

Answer 1

The false statement is d i.e. SHC stock has more market risk than RGB

Statement 1= Incorrect

As volatilty of SHC stock (25%) is higher than the RGB stock (15%).

Therefore SHC stock is risker than RGB stock

Statement 2 = correct

As per CAPM,

Expected Return = Risk free Rate + Beta * Market risk premium

Market risk premium = 10% -2% = 8%

Expected Return of SHC  = 2% + (0.70* 8%)

Expected Return of SHC  = 7.6%

Statement 3 = correct

Expected Return of RGB= 2% + (1.20 * 8%)

Expected Return of RGB = 11.60%

Statement 4 is incorrect

Since, RGB stock has more market risk than SHC stock