Question

Please help me solve this question:

The risk-free rate is 2%. Stock A is expected return is 18% with a beta of 1.7 Stock B expected return is 15% with a beta of 1.3. What is the risk-reward ratio of each and which is the better choice of ignoring the investor risk preference?

Answer 1

risk reward ratio = (expected return - risk free rate) / beta

for stock A

=> (18%-2%) / 1.7

=>9.41.

for stock B

=>(15%-2%) / 1.3

=>10.

A risk taking investor will even go for stocks with lesser risk reward ratio (i.e stock A here).

A conservative investor will go for stocks with a higher risk reward ratio (i.e stock B here).