Question

1. Tables below shows the standard deviations over the last five years and the correlations between the returns of the stocks and the market.

	Stdev			Stock A	Stock B	Market
Stock A	23.00%		Stock A	1.0	0.5	0.3
Stock B	13.00%		Stock B	0.5	1.0	0.8
Market	18.00%		Market	0.3	0.8	1.0

1. Calculate the CAPM beta for each stock. b. Which stock had the greater total risk? Explain. c. Which stock had the greater market risk? Explain. d. Which stock had the greater idiosyncratic (non-market) risk? Explain

Answer 1

a. CAPM beta = correlation(security, market)*securty/ market

For stock A , A = 0.3*0.23/0.18 = 0.383   

For stock B , B = 0.8*0.13/0.18 = 0.578

b. only measures systematic risk. However, standard deviation measures total risk, so high StDV will have high risk. Hence Stock A has high total risk.

c. Market risk is measured by . High will have high market risk. Hence stock B has high market risk,

d. unsystematic risk =(total variance - systematic variance )^0.5

for A, non-market risk = (0.23^2 - (A*0.18)^2)^0.5 = 21.9%

for B non-market risk = (0.13^2 - (B*0.18)^2)^0.5 = 21.9%= 7.79%

So non-market risk for A is high.