Case Analysis - Week3 luating Risk and Return Analysis Stock X has a 1 devitin h

Question

Case Analysis - Week3 luating Risk and Return Analysis Stock X has a 1 devitin has a 10% expected return, a beta coefficient of 09, and a 35% standard deviation of expe cted returns. Stock Y has a 12 5% expected return, a beta coefficient of 12, and a 25% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%. Questions: Please show all calculations. Standard devia-ton 1. Calculate each stock's coefficient of variation. Eyoocaeun 2. Which stock is riskier for a diversified investor? 3. Calculate each stock's required rate of return. 4. On the basis of the two stocks' expected and required returns, which stock would be more attractive to a diversified investor? 5. Calculate the required return of a portfolio that has $7,500 invested in Stock X and $2,500 invested in Stock Y 5. If the market risk premium increased to 6%, which of the two stocks would have the larger increase in its required return?

Explanation / Answer

1. Stock X's coefficient of variation = 0.35/0.10 = 3.5

  Stock Ys coefficient of variation = 0.25/0.125 = 2

2. Stock X is more riskier than stock Y.

3. Stock X's required return = 6% + 0.9 (5%) = 10.5%

Stock Y's required return = 6% + 1.2 (5%) = 12.0%

4. Stock Y

5. Reuired return of portfolio = 75% (10.5%) + 25% (12%) = 10.875%

6. STOCK Y

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