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Risk-return relationship

I need help on Q4.

How much will Sarah (or any diversified investor) require/expect to earn on each stock (given its riskiness) in order to hold it? In other words, establish the risk-return relationship: build up the CAPM equation using the calculated portfolio risk impact of each stock relative to the market proxy (The Vanguard Index 500 Trust).

Please provide step-by-step solution.

Solution Preview

See the attached file. Thanks

1. Calculate the variability (standard deviation) of the stock returns of California REIT and Broun Group during the past two years (1989 and 1990. How variable are they compared with Vanguard Index 500 Trust? Which stock appears to be riskiest?

Vanguard Index 500 Trust California REIT Brown Group
Standard Deviation of Return 4.64% 7.94% 8.67%

Both stocks have higher variability as compared to Vanguard Index 500 Trust. Brown Group appears to be more risky as it has the highest standard deviation.
2. Suppose Beta's position had been 99% of equity funds invested in the index fund, and 1 % in the individual stock. Calculate the variability of this portfolio using each stock. How does each stock affect the variability of the equity investment, and which stock is the riskiest? Explain how this makes sense in view of your ...

Solution Summary

This post discussed on establishing the risk-return relationship and building CAPM equation.

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