6. Problem 8.06 (Expected Returns)

eBook Problem Walk-Through

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

Probability	A		B
0.1	(10	%)	(35	%)
0.1	3		0
0.6	12		20
0.1	22		30
0.1	32		46

1. Calculate the expected rate of return, , for Stock B ( = 11.90%.) Do not round intermediate calculations. Round your answer to two decimal places.

   %

2. Calculate the standard deviation of expected returns, _A, for Stock A (_B = 20.12%.) 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?

   1. 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.
   2. 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.
   3. 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.
   4. 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.
   5. 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.

   -Select-IIIIIIIVVItem 4

3. Assume the risk-free rate is 4.5%. 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?

   1. 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.
   2. 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.
   3. 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.
   4. 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.
   5. 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.