eBook Problem Walk-Through

Stocks A and B have the following probability distributions of expected future returns:

Probability A B

0.1 (14 %) (26 %)

0.1 6 0

0.6 15 24

0.1 23 26

0.1 30 43

Calculate the expected rate of return, , for Stock B ( = 13.50%.) Do not round intermediate calculations. Round your answer to two decimal places.

%

Calculate the standard deviation of expected returns, A, for Stock A (B = 17.78%.) Do not round intermediate calculations. Round your answer to two decimal places.

%

Now calculate the coefficient of variation for Stock B. Do not round intermediate calculations. Round your answer to two decimal places.

Is it possible that most investors might regard Stock B as being less risky than Stock A?

If Stock B is less highly correlated with the market than A, then it might have a lower beta than Stock A, and hence be less risky in a portfolio sense.

If Stock B is less highly correlated with the market than A, then it might have a higher beta than Stock A, and hence be more risky in a portfolio sense.

If Stock B is more highly correlated with the market than A, then it might have a higher beta than Stock A, and hence be less risky in a portfolio sense.

If Stock B is more highly correlated with the market than A, then it might have a lower beta than Stock A, and hence be less risky in a portfolio sense.

If Stock B is more highly correlated with the market than A, then it might have the same beta as Stock A, and hence be just as risky in a portfolio sense.

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Assume the risk-free rate is 3.5%. What are the Sharpe ratios for Stocks A and B? Do not round intermediate calculations. Round your answers to four decimal places.

Stock A:

Stock B:

Are these calculations consistent with the information obtained from the coefficient of variation calculations in Part b?

In a stand-alone risk sense A is less risky than B. If Stock B is more highly correlated with the market than A, then it might have the same beta as Stock A, and hence be just as risky in a portfolio sense.

In a stand-alone risk sense A is less risky than B. If Stock B is less highly correlated with the market than A, then it might have a lower beta than Stock A, and hence be less risky in a portfolio sense.

In a stand-alone risk sense A is less risky than B. If Stock B is less highly correlated with the market than A, then it might have a higher beta than Stock A, and hence be more risky in a portfolio sense.

In a stand-alone risk sense A is more risky than B. If Stock B is less highly correlated with the market than A, then it might have a lower beta than Stock A, and hence be less risky in a portfolio sense.

In a stand-alone risk sense A is more risky than B. If Stock B is less highly correlated with the market than A, then it might have a higher beta than Stock A, and hence be more risky in a portfolio sense.

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