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Calculating Risk Using Beta & Standard Deviation of Return

Common stock A has an expected return of 10%, a standard deviation of future returns of 25%, and a beta of 1.25. Common stock B has an expected return of 12%, a standard deviation of future returns of 15%, and a beta of 1.50. Which stock is riskier?

Why is beta an important part of the equation?

Explain.

Solution Preview

Please see the attached excel file which has the answers to the questions in an excel spreadshseet.

(see attachment for data table)

Which stock is riskier?

The risk of holding a stock has two components- systematic risk and unsystematic (unique) risk
Thus, Total risk = Systematic risk + Unsystematic risk

Systematic risk, also called market risk, influences a large number of firms..
Unsystematic (unique) risk affects a single firm or a small number of firms.

Systematic Risk is the risk associated with macroeconomic factors such as inflation, recession, changes in interest rates, natural shocks like hurricanes, droughts, earthquakes and by war and other political events etc.

Unsystematic (unique) risk is associated with company specific evants such as labor problems, litigation, company winning contracts, changes in management of a ...

Solution Summary

Questions on risk (as measured by beta and standard deviation of return) and return have been answered clearly and extensively in words with references.

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