Ariana Kerantzasv ? tivity: Evaluating risk and return PM EDT Excel Online Struc

Question

Ariana Kerantzasv ? tivity: Evaluating risk and return PM EDT Excel Online Structured Activity: Evaluating risk and return Stock × has a 10.0% expected return, a beta coefficient of 0.9, and a 30% standard deviation of expected returns. Stock Y has a 12.0% expected return, a beta coefficient of 1.1, and a 30.0% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%. The data has been collected in the Microsoft Excel Online file below, Open the spreadsheet and perform the required analysis to answer the questions below. a. Calculate each stock's coefficient of variation, Round your answers to two decimal places. Do not round intermediate calculations b. Which stock is riskier for a diversified investor? L For diversified investors th relevant risk is measured by beta. Therefore, the stock with the higher beta is less risky. Stock Y has the higher beta so Il. For diversified investors the relevant risk is measured by beta. Therefore, the stock with the higher beta is more risky. Stock Y has the higher beta so t 11. Fordiversified investors the relevant risk is measured by standard deviation o expected returns. Therefore, the stock with the higher standard deviation IV. For diversified investors the relevant risk is measured by beta. Therefore, the stock with the lower beta is more risky. Stock X has the lower beta so it is less risky than Stock X. more risky than Stock x. of expected returns is more risky. Stock X has the higher standard deviation so it is more risky than Stock Y more risky than Stock Y Next Back

Explanation / Answer

a.

Coefficient of variation of stock X = Standard deviation of stock X / Expected return of stock X

= 30% / 10%

= 3

Coefficient of variation of stock X is 3 times.

Again,

Coefficient of variation of stock Y = Standard deviation of stock Y / Expected return of stock Y

= 30% / 12%

= 2.50

Coefficient of variation of stock Y is 2.50 times.

b.

For a diversified investors, relevant risk is measured by beta. therefore, a stock with higher beta is considered as more risky. Beta of stock Y is higher than beta of stock X, so, stock Y is more risky than stock X.

Option (B) is correct answer.

c.

Required rate of return of stock X = Risk free rate + (risk premium × beta of X)

= 6% + (5% × 0.90)

= 6% + 4.50%

= 10.50%

Required rate of return of stock X is 10.50%.

Again,

Required rate of return of stock Y = Risk free rate + (risk premium × beta of Y)

= 6% + (5% × 1.10)

= 6% + 5.50%

= 11.50%

Required rate of return of stock Y is 11.50%.

d.

Expected return of stock X is 10% and required rate of return is 10.50%. Since required return is more than expected return, so Stock X is not attractive for investment. again, Expected return of stock Y is 12% and required rate of return is 11.50%. Since required return is less than expected return, so Stock Y is attractive for investment.

Stock Y is attrative investment option.

e.

$4,000 invested in stock X and $6,000 invested in stock Y, Weight of stock X is 40% and weight of stock Y is 60%.

Expected return of portflio = (40% × 10%) + (60% × 12%)

= 4% + 7.20%

= 11.20%

Expected return of portfolio is 11.20%.

f.

if market risk premium increase to 6% from 5% then required return of stock Y increases more than required rate of return of stock X, because beta of stock Stock Y is more than beta of stock X.

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