Expected returns Stocks A and B have the following probability distributions of
ID: 2779939 • Letter: E
Question
Expected returns Stocks A and B have the following probability distributions of expected future returns: Probability A B 0.1 -14% -36% 0.2 3 0 0.3 12 23 0.2 18 25 0.2 33 43 Calculate the expected rate of return, rB, for Stock B (rA = 13.00%.) Do not round intermediate calculations. Round your answer to two decimal places. % Calculate the standard deviation of expected returns, A, for Stock A (B = 22.30%.) Do not round intermediate calculations. Round your answer to two decimal places. % Now calculate the coefficient of variation for Stock B. Round your answer to two decimal places. Is it possible that most investors might regard Stock B as being less risky than Stock A? If Stock B is less highly correlated with the market than A, then it might have a higher beta than Stock A, and hence be more risky in a portfolio sense. If Stock B is more highly correlated with the market than A, then it might have a higher beta than Stock A, and hence be less risky in a portfolio sense. If Stock B is more highly correlated with the market than A, then it might have a lower beta than Stock A, and hence be less risky in a portfolio sense. If Stock B is more highly correlated with the market than A, then it might have the same beta as Stock A, and hence be just as risky in a portfolio sense. If Stock B is less highly correlated with the market than A, then it might have a lower beta than Stock A, and hence be less risky in a portfolio sense.
Explanation / Answer
rB= 0.1(-36%) + 0.2(0%) + 0.3(23%) + 0.2(25%) + 0.2(43%) = 16.9%
A = [(-14% – 13%)2(0.1) + (3% – 13%)2(0.2) + (12% – 13%)2(0.3)+ (18% – 13%)2(0.2) + (33% – 13%)2(0.2)]0.5 = 13.35%
CVA = A/ rA = 13.35%/13% = 1.03, while
CVB = B/ rB = 22.30%/16.9% = 1.32
No, investors wouldn't regard Stock B as being less risky than Stock A.
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