The expected rate of return for the stock of CornhuskerEnterprises is 20%, with

Question

The expected rate of return for the stock of CornhuskerEnterprises is 20%, with a standard deviation of 15%. Theexpected rate of return for the stock of Mustang Associates is 10%,with a standard deviation of 9% a) which stock would you consider to be riskier? why? b) if you knew that the beta coeffcient of Cornhusker stock is1.5 and the beta of mustang is 0.9, how would your answer to Part Achange? The expected rate of return for the stock of CornhuskerEnterprises is 20%, with a standard deviation of 15%. Theexpected rate of return for the stock of Mustang Associates is 10%,with a standard deviation of 9% a) which stock would you consider to be riskier? why? b) if you knew that the beta coeffcient of Cornhusker stock is1.5 and the beta of mustang is 0.9, how would your answer to Part Achange?

Explanation / Answer

There are many different types of risk... a) The risk of a stock is the standard deviation of itsreturns. Since Cornhusker has a standard deviation of 15% andMustang has a standard deviation of 9%, Cornhusker is morerisky. b) Beta measures the correlation of the stock with the market(typically the S&P500). This risk that results from thiscorrelation is known as systematic risk. This is the riskthat you are compensated for in the stock's pricing as ittheoretically cannot be diversified away. Idiosyncratic riskis the other component of risk in the stock's price. It isnot priced into the stock as it can be diversified away. However, it still does affect the distribution of the stock'sreturns. Regardless, since Cornhusker has a higher beta and greater standarddeviation of returns, it is more "risky" regardless of whatdefinition you use, overall risk or systematic risk.

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