Question

Consider the following information on Stocks I and II:

State of Economy	Probability of State of Economy	Rate of Return if State Occurs
		Stock I	Stock II
Recession	.25	.04	−.22
Normal	.60	.22	.15
Irrational exuberance	.15	.16	.45

The market risk premium is 7 percent, and the risk-free rate is 4 percent.

a.	Calculate the beta of each stock. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
b.	Calculate the standard deviation of each stock. (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
c.	Which stock has the most systematic risk?
d.	Which one has the most unsystematic risk?
e.	Which stock is “riskier”?

Answer 1

1. The beta of stock I = 4.2
The beta of stock II = 2.083

2. STANDARD DEVIATION OF STOCK I=7.54%
STANDARD DEVIATION OF STOCK II= 21.32%

3. The stock I has the most systematic risk because it has the highest beta.
4. Stock II has the most unsystematic risk because it has an overall high risk (s.d or variance) and less systematic risk.
5. Stock II has the risker because it has an overall high risk (that is high standard deviation and variance).

let Stock I = X : Stock II 4. - py P(x-x) ² (4-5) ² PX y 0.25 0.04 -0.22 (stolo - 0x 0x ☺ 0.15 0 0.16 0.45 EP(y-7)= ? PX= 166). Ep4 =10-25%. EP(x-7) Vx? 0-166 T57.240). Rx = 16.6%. Ry = 10.25% | 78= 4.5*7.) Vg3 454-684- = 0327) I CAPM Re- Pt+ (RM-Rf) & Standard deviation StockI: 16.6= 4 + (7-4) Bx 1 * x = 4.2 Stock II: 10.25 = 4 + (7-4) By 1 By = 2.083