The Standard Deviation

Calculate the standard deviation of the returns for Company 1, Company 2, and the Market Index. Do you think the standard deviation can reflect the stocks’ risks? And why?4. Construct a scatter diagram graph that shows Company 1’s and Company 2’s returns on the vertical axis and the Market Index’s returns on the horizontal axis. What’s the relationship between the two stocks from your observation?5. Estimate or use data to find Company 1’s and Company 2’s betas, as the slopes of regression lines with stock returns on the vertical axis (y-axis) and market return on the horizontal axis (x-axis). Are these betas consistent with your graph? Do you think beta can reflect the stocks’ risks? And why?6. You need to determine the risk-free rate. What will be your approach and why do you select this method? How much the rate will be?7. What’s the market risk premium? Assume that the market risk premium is 5.5%. What is the expected return on the market? Use the SML equation to calculate the two companies’ required returns.8. If you formed a portfolio that consisted of 50% Company 1 stock and 50% Company 2 stock, what would be its beta and its required return? How will the portfolio hedge the risk?9. Suppose an investor wants to include any one of the two stocks that you recommended in his or her portfolio. Stocks A, B, and C are currently in the portfolio, and their betas are 0.869, 1.985, and 1.02, respectively. Recommend a stock from the two stocks you’ve selected to her/him and calculate the new portfolio’s required return if it consists of 25% of the company you’ve recommended, 15% of Stock A, 40% of Stock B, and 20% of Stock C. Give your comments to risk of the new portfolio. Do you recommend it or not? And why?

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