Calculate the expected rate of return, , for Stock B ( = 12.00%.) Do not round intermediate calculations. Round your answer to two decimal places. % Calculate the standard deviation of expected returns, σA, for Stock A (σB = 20.05%.) Do not round intermediate calculations. Round your answer to two decimal places. % Now calculate the coefficient of variation for Stock B. Do not round intermediate calculations. Round your answer to two decimal places. Assume the risk-free rate is 3.5%. What are the Sharpe ratios for Stocks A and B? Do not round intermediate calculations. Round your answers to four decimal places.
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Stocks A and B have the following probability distributions of expected future returns:
| Probability | A | B | ||
| 0.1 | (10 | %) | (34 | %) |
| 0.2 | 4 | 0 | ||
| 0.4 | 14 | 23 | ||
| 0.2 | 18 | 28 | ||
| 0.1 | 30 | 39 |
- Calculate the expected
rate of return , , for Stock B ( = 12.00%.) Do not round intermediate calculations. Round your answer to two decimal places.%
- Calculate the standard deviation of expected returns, σA, for Stock A (σB = 20.05%.) Do not round intermediate calculations. Round your answer to two decimal places.
%
Now calculate the coefficient of variation for Stock B. Do not round intermediate calculations. Round your answer to two decimal places.
Assume the risk-free rate is 3.5%. What are the Sharpe ratios for Stocks A and B? Do not round intermediate calculations. Round your answers to four decimal places.
Stock A:
Stock B:
Expected Return = Σ of Probability X Return
| Probability | Return | Stock A | Stock B | |
| Stock A | Stock B | |||
| A | B | C | AXB | AXC |
| 0.1 | -10 | -34 | -1 | -3.4 |
| 0.2 | 4 | 0 | 0.8 | 0 |
| 0.4 | 14 | 23 | 5.6 | 9.2 |
| 0.2 | 18 | 28 | 3.6 | 5.6 |
| 0.1 | 30 | 39 | 3 | 3.9 |
| Expected rate of return (%) | 12 | 15.3 | ||
Expected rate of return for Stock B = 15.30%
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