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Determining Risk of Stocks

Stock: Std. Dev. Beta
ABC 12.5% 1.0
FGH 8.0% 0.5
MNO 20.2% 2.4
TUV 15.3% 3.0
1. a. According to the information listed above, which of the stocks would be considered riskiest by itself (2 pts.)?

b. Which one would be the riskiest in a diversified portfolio of investments (2 pts.)?

2. Stock Std. Dev. Beta
A 0.15 0.79
B 0.25 0.61
C 0.20 1.29

If you are a risk minimizer, you should choose Stock ________ if it is to be held in isolation and Stock _______ if it is to be held as part of a well-diversified portfolio (2 pts.).

3. If a stock has a beta coefficient of 1.2, the return in the market is expected to be 14%, and the risk-free rate is 5%, then the Capital Asset Pricing Model says that the rate of return for the stock should be _________% (5 pts).

4. Sharon Stonewall currently has an investment portfolio that contains 10 stocks that have a total value of $160,000, and has a beta of 1.0. She wants to invest $40,000 in a stock with a beta of 2.0. After adding the new stock to her existing portfolio, what will the portfolio beta be? (5 pts.)

5. Given the following information, compute the standard deviation of Investment A if the Expected Return = 13% (5 pts.):
Return Probability
20% 0.5
10% 0.4
-10% 0.1

6. The following information applies to Cyber Soda:
Probability Return
0.2 2.0%
0.3 12.0%
0.5 5.0%
And, the Expected Return of the stock = 6.5.

a. Calculate the Standard Deviation (5 pts):
b. Calculate the Coefficient of Variation (5 pts.):

7. If the risk-free rate is 7%, the expected return on the market is 10%, and the expected return on Security J is 13%, what is the beta of Security J? (5 pts.)

8. Assume you can only buy 1 of the following 2 securities. Which one would you prefer? (Hint: calculate the Expected Return, the Standard Deviation and the Coefficient of Variance. You will want to own the stock that has less risk per unit of expected return).
Asset X Asset Y
Prob. Outcome Prob. Outcome
.1 -3% .05 -3%
.1 2 .1 2
.25 5 .3 5
.25 8 .3 8
.3 10 .25 10

>Expected Returns: (4 pts.)
Asset X:

Asset Y:

>Standard Deviations: (6 pts.)
Asset X:

Asset Y:

>Coefficients of Variation: (4 pts.)
Asset X:

Asset Y:

So, if you had to make a choice, which stock would you pick? Why? (5 pts.)
Asset X OR Asset Y?

Why:

Solution Preview

Please see attachment.

1.
Stock Std. Dev. Beta
ABC 12.50% 1
FGH 8.00% 0.5
MNO 20.20% 2.4
TUV 15.30% 3

a. According to the information listed above, which of the stocks would be considered riskiest by itself?

The standard deviation is the indicator of stand-alone risk. From the above table, you will observe that the riskiest would be Stock MNO.

b. Which one would be the riskiest in a diversified portfolio of investments?

Beta measures the variability, of a stock's return, in relation to the market. From the above table, the stock with the greatest risk in a portfolio would be Stock ABC.

2.
Stock Std. Dev. Beta
A 0.15 0.79
B 0.25 0.61
C 0.2 1.29

If you are a risk minimizer, you should choose Stock C if it is to be held in isolation and Stock A if it is to be held as part of a well-diversified portfolio.

3. If a stock ...

Solution Summary

The risks of stocks are determined. The riskiest in a diversified portfolio of investments are determined.

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