Based on the following information: Average Rate of Return Expected Rate of Retu

Question

Based on the following information: Average Rate of Return Expected Rate of Return |Standard Deviation (o) for the past 10 Years for the next 10 Years of stock returns based Stock A Stock B Which of the following two statements are correct? 12% 16% on the past 10 Years 27% 36% | 1596 8% S1: Stock A has a higher level of stand-alone risk than Stock B. S2: In the past 10 years Stock B has provided a better risk/return trade-off than Stock A to investors. a) b) c) d) S1 is correct but S2 is false. S2 is correct but S1 is false. Both statements are correct. Both statements are false.

Explanation / Answer

d) Both statements are false

Explanation: Standard deviation of stock returns based on past 10 years is an indication of stand-alone risk of particular stock. For stock A, it is less than that of stock B, therefore, stand-alone risk of stock A is actually less than that of B. Hence statement S1 is false.

Risk return trade-off of stock A based on past 10 years = 27/15% = 1.8  

Risk return trade-off of stock B based on past 10 years = 36%/8% = 4

Clearly, stock B has a higher risk-return ratio, which means higher risk as compared to returns. Therefore, stock A has provided a better risk-return tradeoff. hence statement S2 is false.

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