6. Problem 8.06 (Expected Returns)

eBookProblem Walk-Through

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

Probability	A		B
0.1	(5	%)	(35	%)
0.1	5		0
0.5	12		21
0.2	20		29
0.1	35		47

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 = 20.64%.) 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?

A. 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.

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.

C. 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.

D. 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.

E. 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.

Item 4

Assume the risk-free rate is 1.5%. 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?

A. 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.

B. 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.

C. 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.

D. 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.

E. 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.