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# Expected Return, Standard Deviation, and Beta

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1. 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? Explain.

2. a. Suppose you own \$1 million worth of 30-year Treasury bonds. Is this asset risk-less? b. Can you think of an asset that is truly risk-less?

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EXPECTED RETURN, STANDARD DEVIATION, AND BETA

1. 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?

Expected returns from an invested are basically the possible outcomes or benefits that an investment would generate. Comparing Common stock A with an expected return of 10% and Common Stock B with an expected return of 12%, common stock B is expected to earn more.
Keown et al. (2002) noted that standard deviation is a measure of the spread or dispersion about the mean of a probability distribution. To these authors standard deviation operationally measures risk or the prospect of an unfavourable outcome. ...

#### Solution Summary

An analysis of stocks is given. This analysis allows for a determination of the riskier stocks to be given. The solution contains two references.

\$2.19

## Expected Return, Standard Deviation, CAPM, Beta, CAL ( Capital Allocation Line)

1 Asset Expected Return Standard Deviation Weight
X 15% 22% 0.5
Y 10% 8% 0.4
Z 6% 3% 0.1

What is the expected return on this three -asset portfolio?
2) Karen Kay, a portfolio manager at Collins Asset Management, is using the capital asset pricing model for making recommendations to her clients. Her research department has developed the information shown in the following exhibit.
Forecasted returns, Standard deviations, and Betas
Forecasted return Standard deviation Beta
Stock X 14% 36% 0.8
Stock Y 17% 25% 1.5
Market Index 14% 15% 1
Risk-free rate 5%

a) Calculate the expected return on the stocks based on CAPM
b) Identify and justify which stock would be more appropriate for an investor who wants to
i) Add this stock to a well- diversified equity portfolio.
ii) Hold this stock as a single-stock portfolio

6. True or False and Explain
You can construct a portfolio with a Beta of .75 by investing .75 of the budget in T-Bills and the remainder in the market portfolio?

In problems 16-18 below, assume the risk-free rate is 8% and the expected rate of return on the market is 18%

16. A share of stock is now selling for \$100. It will pay a dividend of \$9 per share at the end of the year. Its beta is 1.0. What do the investors expect the stock to sell for at the end of the year.

18. A stock has an expected return of 6%. What is its beta?
For Problems 19-23, assume that you manage a risky portfolio with an expected rate of return of 17% and a standard deviation of 27%. The T-bill rate is 7%.
19. a. Your client chooses to invest 70% of a portfolio in your fund and 30% in a T-bill money market fund. What is the expected return and standard deviation of your client's portfolio?
b. Suppose your risky portfolio includes the following investments in the given proportions:

Stock A 27%
Stock B 33%
Stock C 40%
What are the investment proportions of your client's overall portfolio, including the position in T-bills?
c. What is the reward-to-variability ratio (S) of your risky portfolio and your client's overall portfolio?
d. Draw the CAL of your portfolio on an expected return/standard deviation diagram. What is the slope of the CAL? Show the position of your client on your fund's CAL.