EXPECTED RETURNS Stocks A and B have the following probability distributions of

Question

EXPECTED RETURNS

Stocks A and B have the following probability distributions of expected future returns:

Calculate the expected rate of return, rB, for Stock B (rA = 12.20%.) Do not round intermediate calculations. Round your answer to two decimal places.
%

Calculate the standard deviation of expected returns, ?A, for Stock A (?B = 17.84%.) 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 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.

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.

Probability A B 0.1 (8%) (25%) 0.2 5 0 0.3 11 19 0.3 18 25 0.1 33 43

Explanation / Answer

Stock A

Expected return = 12.20%

Standard dev = 10.25%

Coeff. of Variation = 0.84

Stock B:

Expected return = 15.00%

standard dev = 17.84%

Coeff of variation = 1.19

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.

p(x) return p*x p*(x - mean)^2 0.1 -8.00% -0.008 0.0040804 0.2 5.00% 0.01 0.0010368 0.3 11.00% 0.033 0.0000432 0.3 18.0% 0.054 0.0010092 0.1 33.00% 0.033 0.0043264

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