Consider the following information about Stocks I and Il: Rate of Return if Stat

Question

Consider the following information about Stocks I and Il: Rate of Return if State Occurs State of Economy Probability of State of Economy Stock I Stock Il Recession 0.30 0.09 - 0.24 Normal 0.45 0.16 0.11 Irrational exuberance 0.25 0.10 0.44 The market risk premium is 8 percent, and the risk-free rate is 4 percent. (Round your answers to 2 decimal places. (e.g., 32.16)) The standard deviation on Stock I?s return is percent, and the Stock I beta is 1.05. The standard deviation on Stock II?s return is percent, and the Stock II beta is .59 . Therefore, based on the stock?s systematic risk/beta, Stock is riskier.

Explanation / Answer

Calculating the standard deviation for stock 1

Variance = 10.74%2

Standard deviation = sqroot of variance = 3.277%

Calculating the standard deviation of stock 2

Variance = 634.70%2

Standard deviation = 25.20%

State of Economy Return (R) R - ExpR (R-ExpR)2P Recession(0.30) 9 9-12.40=-3.40 3.468 Normal(0.45) 16 3.6 5.832 Irrational Exuberance(0.25) 10 -2.40 1.44 Expected Return=(9x0.30+16x0.45+10x0.25) 12.40% 10.74%2

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