A. You observe the following information regarding Companies X and Y: —Company X

Question

A. You observe the following information regarding Companies X and Y:

—Company X has a higher expected return than Company Y.
—Company X has a lower standard deviation of returns than Company Y.
—Company X has a higher beta than Company Y.

Given this information, which of the following statements is CORRECT?

Company X has more diversifiable risk than Company Y.

Company X has a lower coefficient of variation than Company Y.

Company X has less market risk than Company Y.

Company X's returns will be negative when Y's returns are positive.

Company X's stock is a better buy than Company Y's stock.

B. Stock A's stock has a beta of 1.30, and its required return is 13.25%. Stock B's beta is 0.80. If the risk-free rate is 2.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

C. Mulherin's stock has a beta of 1.23, its required return is 9.50%, and the risk-free rate is 2.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

Company X has more diversifiable risk than Company Y.

Company X has a lower coefficient of variation than Company Y.

Company X has less market risk than Company Y.

Company X's returns will be negative when Y's returns are positive.

Company X's stock is a better buy than Company Y's stock.

B. Stock A's stock has a beta of 1.30, and its required return is 13.25%. Stock B's beta is 0.80. If the risk-free rate is 2.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

C. Mulherin's stock has a beta of 1.23, its required return is 9.50%, and the risk-free rate is 2.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

Explanation / Answer

a. The answer is the 2nd statement - Company X has a lower coefficient of variation than Company Y.

This is because company X has a lower standard deviation of returns than Company Y. Coefficient of variation = standard deviation/mean*100. Also mean of X will be higher as its expected return is higher than Y. So, the numerator (standard deviation) is lower and denominator (mean) is higher in case of X. This will lower its coefficient of variation than Company Y.

b. rf = 2.75%. let rm be x. so, return = rf+beta*(rm-rf)

for Stock A: 13.25% = 2.75%+1.30*(x-2.75%)

or x = 10.83%

For stock B: return = 2.75%+0.80*(10.83 - 2.75)

return = 2.75%+6.464 = 9.214%.

c. return = rf+beta*(rm-rf)

9.5% = 2.3%+1.23*(rm - 2.3%)

7.2% = 1.23rm - 2.829%

10.029% = 1.23rm

or rm = 10.029/1.23 = 8.15%

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.