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.

... SML gives an equation that calculates the expected ... and standard deviation of market portfolio (calculated above) Therefore, we can calculate the beta...

...beta of stock= beta A= 1.68 (calculated above) return... We first calculate required returns using CAPM and ...returns, standard deviation of return, beta, risk etc. ...

...Calculate the standard deviations of returns for both Stock X ...Risk free rate is calculated assuming that the stock ... a. Use a spreadsheet (or calculator with a ...

...beta for the two stocks is calculated first using... Capital Asset Pricing Model) equation to calculate the required ... The risk-free rate is 6%, and the required ...

Corporate Finance, calculating annual returns. ... and the Market Index, and then calculate average returns... (Hint: Remember, returns are calculated by subtracting ...

... a. Use a spreadsheet or calculator with a linear ...Calculate th deviations of returns for both stock X and the ... βA= beta of portfolio= 0.565 (calculated above) rm ...

... The SML is derived by using the function: SML = Risk-free rate + (Beta... Market return 7% Risk-free rate 4% Beta 1.25 Fair rate of ... (a) Calculate the standard...

... 3.21% = 10.21% Analysis Beta To calculate beta, weekly historical ...Beta is calculated using the LINEST function in ... is not commonly used for calculating the cost ...

... up the CAPM equation using the calculated portfolio risk...Calculate the variability of this portfolio using each stock ...risk as the overall portfolio risk for the ...