Question

Stock X has a 10% expected return, a beta coefficient of 0.9 and a 35% standard deviation of expected returns. stock Y has a 12.5% expected return, a beta coefficient of 1.2 and a 25% standard deviation. The risk-free rate is 6% and the market risk premium is 5%.

1. Calculate each stock’s coefficient of variation

2. Which stock would be more attractive to a diversified investor?

3. Calculate the required return of a portfolio that has $7500 invested in Stock X and $2500 invested in Stock Y

4. If the market risk premium increased to 6%, which of the 2 stocks would have the larger increase in its required return?

Answer 1

1-	stock		X		Y
	co efficient of variance	standard deviation/expected return	350.0%		200.0%
	standard deviation		35%		25%
	expected return		10%		12.50%
2-	Stock Y would be more attractive because its coefficient of variation is low in comparison to X and return is more
3-	required rate of return on stock	risk free rate+(market risk premium)*beta	10.50%		12.00%
	risk free rate		6%		6%
	market risk premium		5%		5%
	beta		0.9		1.2
	reqired return on portfolio
	stock	Investment	weight	required rate of return on stock	weight*required rate of return
	X	7500	0.75	10.5	7.875
	Y	2500	0.25	12	3
		10000	1	required return on portfolio	10.875
4-
	required rate of return on stock	risk free rate+(market risk premium)*beta	11.40%		13.20%
	risk free rate		6%		6%
	market risk premium		6%		6%
	beta		0.9		1.2
	stock Y