Question

Consider the following information about Stocks I and II: Rate of Return If State Occurs State of Probability of Economy State of Economy Stock I Stock II Recession .30 .04 ?.19 Normal .50 .16 .06 Irrational exuberance .20 .05 .39 The market risk premium is 8 percent, and the risk-free rate is 5 percent. (Do not round intermediate calculations. Round your answers to 2 decimal places, e.g., 32.16. Enter your return answers as a percent. ) The standard deviation on Stock I's return is percent, and the Stock I beta is . The standard deviation on Stock II's return is percent, and the Stock II beta is . Therefore, based on the stock's systematic risk/beta, Stock is "riskier".

Answer 1

Expected return and Standard deviation of stock I is calculated in excel and screen shot provided below:

Expected return of stock I is 10.20% and Standard deviation of stock I is 5.81%.

Risk free rate = 5%

Risk premium = 8%

Beta = (Expected return - Risk free rate) / Risk premium

= (10.20% - 5%) / 8%

= 5.20% / 8%

= 0.65

Beta of stock I is 0.65.

b.

Expected return and Standard deviation of stock II is calculated in excel and screen shot provided below:

Expected return of stock II is 5.10% and Standard deviation of stock II is 20.11%.

Risk free rate = 5%

Risk premium = 8%

Beta = (Expected return - Risk free rate) / Risk premium

= (5.10% - 5%) / 8%

= 0.10% / 8%

= 0.0125

Beta of stock II is 0.0125.

Beta of stock I is higher than Beta of stock II. Based on the stock's systematic risk/beta, Stock I is riskier.