Question

Stocks A and B have the following probability distributions of expected future returns:

Probability	A		B
0.1	(7	%)	(34	%)
0.2	2		0
0.4	14		23
0.2	22		28
0.1	37		44

1. Calculate the expected rate of return, , for Stock B ( = 13.40%.) Do not round intermediate calculations. Round your answer to two decimal places.

   ___ %

2. Calculate the standard deviation of expected returns, σ_A, for Stock A (σ_B = 20.69%.) Do not round intermediate calculations. Round your answer to two decimal places.

   ___ %

   Now calculate the coefficient of variation for Stock B. Do not round intermediate calculations. Round your answer to two decimal places. ___

   Is it possible that most investors might regard Stock B as being less risky than Stock A?

   1. If Stock B is less highly correlated with the market than A, then it might have a higher beta than Stock A, and hence be more risky in a portfolio sense.
   2. If Stock B is more highly correlated with the market than A, then it might have a higher beta than Stock A, and hence be less risky in a portfolio sense.
   3. If Stock B is more highly correlated with the market than A, then it might have a lower beta than Stock A, and hence be less risky in a portfolio sense.
   4. If Stock B is more highly correlated with the market than A, then it might have the same beta as Stock A, and hence be just as risky in a portfolio sense.
   5. If Stock B is less highly correlated with the market than A, then it might have a lower beta than Stock A, and hence be less risky in a portfolio sense.

3. Assume the risk-free rate is 2.5%. What are the Sharpe ratios for Stocks A and B? Do not round intermediate calculations. Round your answers to four decimal places.

   Stock A: ___

   Stock B: ___

   Are these calculations consistent with the information obtained from the coefficient of variation calculations in Part b?

   1. In a stand-alone risk sense A is less risky than B. If Stock B is less highly correlated with the market than A, then it might have a lower beta than Stock A, and hence be less risky in a portfolio sense.
   2. In a stand-alone risk sense A is less risky than B. If Stock B is less highly correlated with the market than A, then it might have a higher beta than Stock A, and hence be more risky in a portfolio sense.
   3. In a stand-alone risk sense A is more risky than B. If Stock B is less highly correlated with the market than A, then it might have a lower beta than Stock A, and hence be less risky in a portfolio sense.
   4. In a stand-alone risk sense A is more risky than B. If Stock B is less highly correlated with the market than A, then it might have a higher beta than Stock A, and hence be more risky in a portfolio sense.
   5. In a stand-alone risk sense A is less risky than B. If Stock B is more highly correlated with the market than A, then it might have the same beta as Stock A, and hence be just as risky in a portfolio sense.

Answer 1