Question

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

Probability	A		B
0.1	(5	%)	(22	%)
0.2	2		0
0.5	13		23
0.1	21		25
0.1	29		45

1. Calculate the expected rate of return, , for Stock B ( = 11.40%.) 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 = 17.67%.) 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 lower beta than Stock A, and hence be less risky in a portfolio sense.
   2. 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. 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.
   4. 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.
   5. 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.

   -Select-IIIIIIIVVItem 4

3. Assume the risk-free rate is 3.5%. 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 higher beta than Stock A, and hence be more risky in a portfolio sense.
   2. 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.
   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 higher beta than Stock A, and hence be more risky in a portfolio sense.
   4. 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.
   5. 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.

   -Select-IIIIIIIVV

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

Cell reference -