considerr the following information on Stocks I and II: Rate of Return If State
ID: 2727524 • Letter: C
Question
considerr the following information on Stocks I and II: Rate of Return If State Occurs Probability of State of Economy State of Economy Stock I Stock II Recession .40 .03 -.18 Normal .25 .34 .14 Irrational exuberance .35 .28 .44 The market risk premium is 11 percent, and the risk-free rate is 6 percent. 1-a. What is the beta of each stock? (Do not round intermediate calculations. Round your answers to 2 decimal places.) Beta Stock I Stock II 1-b. Which stock has the most systematic risk? Stock I Stock II 2-a. What is the standard deviation of each stock? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places. Omit the "%" sign in your response.) Standard Deviation Stock I % Stock II %
Explanation / Answer
1a.
Calculation of beta of each stock:
Stock I
State of Economy
Probability
Rate of Return
A
B
A*B
Recession
0.40
0.03
0.0120
Normal
0.25
0.34
0.0850
Irrational exuberance
0.35
0.28
0.0980
Average Rate of return
0.1950
Beta = (Average rate of return - Risk Free Rate) / Market risk Premium
= (0.195 - 0.06) / 0.11 =
1.23
Stock II
State of Economy
Probability
Rate of Return
A
B
A*B
Recession
0.40
-0.18
(0.0720)
Normal
0.25
0.14
0.0350
Irrational exuberance
0.35
0.44
0.1540
Average Rate of return
0.1170
Beta = (Average rate of return - Risk Free Rate) / Market risk Premium
= (0.117 - 0.06) / 0.11 =
0.52
1-b.
Beta of Stock Stock I has most systematic risk as it is closer to 1.
1a.
Calculation of beta of each stock:
Stock I
State of Economy
Probability
Rate of Return
A
B
A*B
Recession
0.40
0.03
0.0120
Normal
0.25
0.34
0.0850
Irrational exuberance
0.35
0.28
0.0980
Average Rate of return
0.1950
Beta = (Average rate of return - Risk Free Rate) / Market risk Premium
= (0.195 - 0.06) / 0.11 =
1.23
Stock II
State of Economy
Probability
Rate of Return
A
B
A*B
Recession
0.40
-0.18
(0.0720)
Normal
0.25
0.14
0.0350
Irrational exuberance
0.35
0.44
0.1540
Average Rate of return
0.1170
Beta = (Average rate of return - Risk Free Rate) / Market risk Premium
= (0.117 - 0.06) / 0.11 =
0.52
1-b.
Beta of Stock Stock I has most systematic risk as it is closer to 1.
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