The annual standard deviation of returns on Stock A’s equity is 31% and the corr

Question

The annual standard deviation of returns on Stock A’s equity is 31% and the correlation coefficient of these returns, with those on the market index (S&P 500 index), is 0.82. Comparable numbers of Stock B are 34% and 0.64.

a. Which stock is riskier? Why?

b. What can you say about Stock A if its correlation coefficient is 0

c. What can you say about Stock A if its correlation coefficient is -1

d. What can you say about Stock A if its correlation coefficient is 1

e. Assume the standard deviation for the market index (S&P 500 index) is 25%, what are betas of stock A and for stock B.

f. Interpret the betas of stock A and stock B you compute in part e

Explanation / Answer

a)Stock B is riskier as its standard deviation is higher.

B) Stock A is not moving in any direction ,The overall risk is 0

C) Stock A is moving in negative direction,so overall risk of portfolio can be minimised to 0

D)Stock A is moving in same direction as stock B so risk can be eliminated but not minimised to 0

E) Beta - Sd of security * correlation coeffcient /SD of market

A = 31 * .82 / 25

      = 1.0168

B = 34 *.64 /25

      = .8704

F)stock A is riskier than stock B as its beta is higher.

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