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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

Stock A has an expected return of 7%, a standard deviation of expected returns of 35%, a correlation coefficient with the market of - 0.3, and a beta coefficient of -0.5. Stock B has an expected return of 12%, a standard deviation of returns of 10%, a 0.7 correlation with the market, and a beta coefficient of l.0. Which security is riskier? Why?

Summary Introduction

To determine: The riskier security and the reason for it.

Portfolio:

The portfolio refers to a group of financial assets like bonds, stocks, and equivalents of cash. The portfolio is held by investors and financial users. A portfolio is constructed in accordance with the risk tolerance and the objectives of the company.

ExpectedReturn on Stock:

The expected return on stock refers to the weighted average of the expected returns on those assets which are held in the portfolio.

Standard Deviation:

The standard deviation refers to the stand-alone risk associated with the securities. It measures how much a data can be dispersed with its standard value. The Greek letter sigma represents the standard deviation.

Coefficient Variation:

The coefficient of variation is a tool to determine the risk. It determines the risk per unit of return. It is used for the measurement when the expected returns are same for two data.

Beta Coefficient:

The beta coefficient is a value used in the Capital Asset Pricing Model (CAPM) to find out the required return for an investment. This coefficient measures whether the investment is less or more volatile in the market.

Explanation

Given,

For stock A,

Expected return is 7%.

Standard deviation is 35%.

Correlation coefficient is 0.3 .

Beta coefficient is 0.5 .

For stock B,

Expected return is 12%.

Standard deviation is 10%.

Correlation coefficient is 0.7 .

Beta coefficient is 0.1 .

  • If it is considered as a diversified portfolio, the Stock A would be less risky than that of Stock B

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