Consider the following information about Stocks I and II.State of EconomyRecessionNormalIrrational exuberanceProbability of Stateof Economy0.150.550.30The market risk premium is 7.5 percent, and the risk-free rate is 4 percent.(a) Compute and identify the stock that has the most systematic risk.(b) Compute and justify the stock that has the most unsystematic risk.(c) Identity and justify which stock is "riskier".Rate of Return if State OccursStock IStock II0.11-0.250.180.110.080.31

It has been given in the question that the risk premium is the 7.5% and the risk-free rate of return…

Answered: (a) Compute and identify the stock that…

Corporate Fin Focused Approach

5th Edition

ISBN:9781285660516

Author:EHRHARDT

Publisher:EHRHARDT

Chapter6: Risk And Return

Section: Chapter Questions

Problem 14P

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Market equity beta measures the covariability of a firms returns with all shares traded on the market (in excess of the risk-free interest rate). We refer to the degree of covariability as systematic risk. The market prices securities so that the expected returns should compensate the investor for the systematic risk of a particular stock. Stocks carrying a market equity beta of 1.20 should generate a higher return than stocks carrying a market equity beta of 0.90. Nonsystematic risk is any source of risk that does not affect the covariability of a firms returns with the market. Some writers refer to nonsystematic risk as firm-specific risk. Why is the characterization of nonsystematic risk as firm-specific risk a misnomer?
An analyst has modeled the stock of a company using the Fama-French three-factor model. The market return is 10%, the return on the SMB portfolio (rSMB) is 3.2%, and the return on the HML portfolio (rHML) is 4.8%. If ai = 0, bi = 1.2, ci = 20.4, and di = 1.3, what is the stock’s predicted return?
What is a characteristic line? How is this line used to estimate a stocks beta coefficient? Write out and explain the formula that relates total risk, market risk, and diversifiable risk.
Consider the following information about Stocks X and Y: State of Economy Probability of State Stock X Returns Stock Y Returns Recession 0.15 0.11 -0.25 Steady 0.55 0.18 0.11 Boom 0.30 0.08 0.31 The market risk premium is 7.5 percent, and the risk-free rate is 4 percent. Which stock has the most systematic risk? Which one has the most unsystematic risk? Which stock is “riskier”? Explain.
Consider information given in the table below and answers the question asked thereafter: State Probability return on stock A Return on stock B A 0.15 10% 9% B 0.15 6% 15% C 0.10 20% 10% D 0.18 5% -8% E 0.12 -10% 20% F 0.30 8% 5% i. Calculate expected return on each stock? On the basis of this measure, which stockyou will choose?ii. Calculate standard deviation of the returns on each stock? On the basis of thismeasure, which stock you will choose?iii. Calculate coefficient of variance of the returns on each stock? On the basis of thismeasure, which stock you will choose?

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(a) Compute and identify the stock that has the most systematic risk. (b) Compute and justify the stock that has the most unsystematic risk. (c) Identity and justify which stock is "riskier".