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Draw distinctions between 'Standard Deviation' and 'Beta' as measures of risk
Draw distinctions between 'Standard Deviation' and 'Beta' as measures of risk.
Suppose you have invested Rs.1,00,000 in the following four stocks:
Stock Amount of Investment
(Rs.)
Beta Variance
A 10,000 1.20 15%
B 40,000 0.95 10%
C 20,000 1.10 12%
D 30,000 1.50 18%
The risk free rate is 6.5% per annum and the expected return on the market portfolio is
12.5%. What is the expected return on your portfolio? What is portfolio systematic risk?
Expert Solution
See explanation.
Step-by-step explanation
Of the 100,000,
10% is invested in A
40% is invested in B
20% is invested in C
30% is invested in D
The expected value of beta
E(beta) = 0.10(1.2) +0.40(0.95) +0.20(1.10)+ 0.30(1.50) =
1.17
According to the CAPM, the expected return of the portfolio =
E(r) = risk-free rate + beta ( market return -risk-free return) =
6.5% + 1.17(12.5%-6.5%) =
6.5% +7.02% =
13.52%
If systematic risk (beta) is not taken into consideration,
the expected value of returns =
0.10(15%) +0.40(10%) +0.20(12%) + 0.30(18%) =
13.30%.
Systematic risk is the risk related to the particular asset and not to the other assets.
This risk is shown by beta.
The total risk premium = beta ( market return - risk-free return)
Unsystematic risk is associated with all assets.
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