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4. Specific versus Market Risk. Figure 12.11 shows plots of monthly rates of return on three stocks versus the stock market index. (The plots are

4. Specific versus Market Risk. Figure 12.11 shows plots of monthly rates of return on three stocks versus the stock market index. (The plots are similar to those in Figure 12.2.) The beta and standard deviation of each stock is given beside its plot. (LO12-1)

a. Which stock is safest for a diversified investor?

For safest of a diversified investor, the safest stocks are Intel with a beta of 1.07 and a standard deviation of 20.5%, and Walmart with a beta of 0.37 and a standard deviation of 16.4%.

b. Which stock is safest for an undiversified investor who puts all her funds in one of these stocks?

c. Consider a portfolio with equal investments in each stock. What would this portfolios beta have been?

d. Consider a well-diversified portfolio made up of stocks with the same beta as Ford. What are the beta and standard deviation of this portfolios return? The standard deviation of the market portfolios return is 20%.

e. What is the expected rate of return on each stock? Use the capital asset pricing model with a market risk premium of 8%. The risk-free rate of interest is 4%

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FIGURE 12.10 Monthly rates of return for the Snake Oil mutual fund and the Standard & Poor's Composite Index FIGURE 12.11 Monthly rates of return for (a) Ford, (b) Pfizer, and (c) Walmart, plus the market portfolio for the five years ending December 2015 (a) Ford return (%) (b) Pfizer return (%) Snake Oil return (%) -20 -20 -10 -15 -10 -10 + 20 15 10 -15 -20 Market return (%) 25 20 15 10+ 5+1 tie 14 -15+ -20 Market return (%) 15 10 10 10 20 Beta = 1.31 Standard deviation = 25.3% -10 -15 Market return (%) 20 15 Beta 90 Standard deviation = 15.3% 10 FIGURE 12.11 (continued) (c) Walmart returns (%) -15 15 T 10 15 Standard deviation = 16.5% + Beta = 26 -10 -15 Market return (%)

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