Question

Stocks A and B have the following probability distributions of expected future returns: Probability A B 0.1 (15%) (28%) 0.2 6 0 0.3 16 22 0.3 24 28 0.1 38 47 Calculate the expected rate of return, rB, for Stock B (rA = 15.50%.) Do not round intermediate calculations. Round your answer to two decimal places. % Calculate the standard deviation of expected returns, σA, for Stock A (σB = 19.85%.) Do not round intermediate calculations. Round your answer to two decimal places. % Now calculate the coefficient of variation for Stock B. Round your answer to two decimal places. Is it possible that most investors might regard Stock B as being less risky than Stock A? 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. 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. 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. 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. 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.

Answer 1

a.

Expected return and standard deviation of stock A is calculated in excel and screen shot provided below:

Expected return of stock A is 15.50% and standard deviation is 13.79%.

b.

Expected return and standard deviation of stock B is calculated in excel and screen shot provided below:

Expected return of stock B is 16.90% and standard deviation is 20.25%.

c.

Standard deviation of stock B is more than Standard deviation of stock A. So, unsystematic risk  of stock B is higher than stock A. total risk of stock B might be lower than stock A, if systematic risk of stock A is higher than systematic risk of stock B. 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

Option (C) is correct answer.