8. Evaluating risk and return Stock X has a 10.5% expected return, a beta coeffi

Question

8. Evaluating risk and return

Stock X has a 10.5% expected return, a beta coefficient of 1.0, and a 30% standard deviation of expected returns. Stock Y has a 13.0% expected return, a beta coefficient of 1.3, and a 25.0% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%.

Calculate each stock's coefficient of variation. Round your answers to two decimal places. Do not round intermediate calculations.
CVx =   
CVy =   

Which stock is riskier for a diversified investor? Answer: 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 it is more risky than Stock X.

Calculate each stock's required rate of return. Round your answers to two decimal places.
rx =
ry =

On the basis of the two stocks' expected and required returns, which stock would be more attractive to a diversified investor? Answer: Stock Y

Calculate the required return of a portfolio that has $6,000 invested in Stock X and $4,500 invested in Stock Y. Do not round intermediate calculations. Round your answer to two decimal places.
rp =

If the market risk premium increased to 6%, which of the two stocks would have the larger increase in its required return? Answer:Stock Y

Explanation / Answer

1. Coefficient of variation = Standard deviation / Expected return

                                       CVx=30/10.5 = 2.857

                                        CVy=25/13 = 1.92        

2. Required rate of return = Rf+(Rm-Rf)

                   Rx=6%+1(5%) =11%

                    Ry=6%+1.3(5%)=12.5%

3. Required return of portfolio = (11%*6000/10500)+(12.5%*4500/10500)

                                                        =11.65%

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