Question

Problem 9-33 Risk, Return, and Their Relationship (LG9-3, LG9-4) Consider the following annual returns of Estée Lauder and Lowe's Companies: Year 1 Year 2 Year 3 Year 4 Year 5 Estée Lauder 23.48 -26.0 17.6 49.9 -16.8 Lowe's Companies -6.08 16.1 4.2 48.0 - 19.0 Compute each stock's average return, standard deviation, and coefficient of variation (Round your answers to 2 decimal places.) Estée Lauder Lowe's Companies Average return Standard deviation Coefficient of variation Which stock appears better?

Answer 1

1).

Formula Year (n) Estee Lauder (Re) 23.40% -26.00% 17.60% 49.90% -16.80% 48.10% 9.62% Lowe's Companies (RI) -6.00% 16.10% 4.20% 48.00% -19.00% 43.30% 8.66% (Re-R)^2 0.018989 0.126878 0.006368 0.162248 0.069802 0.384285 (RI-R)^2 0.021492 0.005535 0.001989 0.154764 0.076508 0.260287 5 Sum of the column T/5 [T/4]^0.5 SD/R Total (T) Average ('R) Sample standard deviation Coefficient of variation 31.00% 3.22 25.51% 2.95

Estee Lauder appears to be a better stock as it has higher returns and standard deviation is not much higher than that of Lowe's.

2). Ranking in terms of total risk means ranking by highest to lowest standard deviation:

Rank 1: Idol Staff (SD = 35%)

Rank 2: Rail Haul (SD = 25%)

Rank 3: Poker-R-Us (SD = 20%)

3). Price paid when bond is called = par value + call premium = 1,000 + (6%*1,000) = 1,060

4). FV = 1,000; PV = 1,035.25; PMT (semi-annual coupon) = coupon rate/2 *par value = (5.65%/2)*1,000 = 28.25; N = 18*2 = 36, solve for RATE.

Semi-annual rate = 2.67% so YTM = 2.67%*2 = 5.34%

5). Statement 2 is false. Bonds are not always less risky than stocks. Lower rated bonds may be more risky than blue-chip stocks.