You have been provided the following summary of the performance of stocks A and B; of the market index; and the risk free rate.

	A	B	Market Index	Risk Free Asset
Average annual return	22%	14%	9%	5%
Standard deviation of annual returns	18%	8%	4%
Correlation coefficient A and B	0.75
Correlation coefficient A and Market	0.35
Correlation coefficient B and Market		0.25

 Answer the followings

a. Which stock is riskier – A or B? 

b. Which stock provides a higher reward to risk? 

c. What is the lowest risk possible in a portfolio consisting only of A and B? What is the composition of such a portfolio? 

d. Can you have a portfolio of only the Market Index and Risk Free Asset such that it has the same risk as the portfolio of A and B above? What would be the expected return of this portfolio?

e. Apply Capital Asset Pricing Model (CAPM) to estimate the expected returns of A and B. Compare it to the actual expected returns to decide if A and B are over or under priced by the stock market.

Answer rating: 100% (QA)

a Stock A is riskier than stock B because it has a higher standard deviation of annual returns 18 compared to 8 b To determine which stock provides a higher reward to risk we can calculate the Sharpe ... View the full answer