Unique versus Market Risk.
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Figure in the attachment shows plots of monthly rates of return on three stocks versus the stock market index. The beta and standard deviation of each stock is given beside its plot.
a. Which stock is safest for a diversified investor?
b. Which stock is safest for an undiversified investor who puts all her funds in one of these
stocks?
e. What is the expected rate of return on each stock? Use the capital asset pricing model with
a market risk premium of 8 percent. The risk-free rate of interest is 4 percent.
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Solution Summary
The solution explains how to determine the safest stock for undiversified and diversified investor and to calculate the expected return on stock.
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a. Which stock is safest for a diversified investor?
A diversified investor would look at the beta of the stock since that represents the risk of the stock in a portfolio. The lower the beta lower is the risk. The General Electric stock with the lowest beta is the ...
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