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Topic: Selection of Stock on the basis of Risk and Return

Last Date   25-jan-2018

Discussion Question:

Selection of an efficient stock from the stock market is a crucial decision that is not only vital for investment but also pave the ways for value addition.  Stocks are selected on returns and volatility basis that carries a tradeoff.  In this context, calculation of required return (RR) with the help of Security Market Line (SML) and stock beta may help a lot to any investor. Assume you are going to invest in stock exchange where you are a new investor and you are facing an issue of the selection of stock among different alternative available in the market. Follwoing information regarding stocks and market is available to you:

Particulars Stock A (%) Stock B (%) Market (%)
Standard Deviation 27 28 18
Correlation of stocks with market 0.8 0.5  
Market Return     15
Risk Free Return     8

Based on above information:

  1. You are required to calculate required rate of return of Stock A and Stock B
  2. Declare yourself either a risk taker investor or risk averse investor
  3. Considering your risk appetite (either risk taker or risk averse) you are required to suggest which Stock should be selected. Provide a reason to support your selection (in bullet form). Your selection should be based on your risk appetite assumption i.e. first declare yourself as either risk taker or risk averse investor and then select stock based on calculations in part 1.

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solution uplode please

uff yeh to sir k oper se guzer gia hai koi  solution upload kr de?

i think chapter 22 to 26 of handout should help in solving the GDB

Please Discuss here about this GDB.Thanks

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mgt201 gdb solution

GDB ans MGT 201

Particulars

Stock A (%)

Stock B (%)

Market (%)

Standard Deviation

27

28

18

Correlation of stocks with market

0.8

0.5

 

Market Return

 

 

15

Risk Free Return

 

 

8

  • SML Linear Equation for the Required Return of any Stock A:

rA = rRF + (rM - rRF ) β A

rA =8 +(15-8)1.2

rA =16.4

Beta Stock A = σ A ρ AM / σ M

                            = 27*0.8/18

                           =1.2

 

SML Linear Equation for the Required Return of any Stock B:

rB= rRF + (rM - rRF ) β B

rB =8 +(15-8)0.777

rB =13.439

Beta Stock B = σ B ρ BM / σ M

                            = 28*0.5/18

                           =0.777

Rashid Ali Ramay

03028104513

Rashid.ali02@nbp.com.pk

 

  • Declare yourself either a risk taker investor or risk averse investor

I am a risk averse investor.

Rashid Ali Ramay

03028104513

Rashid.ali02@nbp.com.pk

 

  • Considering your risk appetite (either risk taker or risk averse) you are required to suggest which Stock should be selected. Provide a reason to support your selection (in bullet form). Your selection should be based on your risk appetite assumption i.e. first declare yourself as either risk taker or risk averse investor and then select stock based on calculations in part 1

Answer

  • After the study of market risk and diversification of risk I would like to choose stock’s B Because correlation coefficient is smaller than stock’s A

 

Particulars

Stock A (%)

Stock B (%)

Market (%)

Standard Deviation

27

28

18

Correlation of stocks with market

0.8

0.5

 

Market Return

 

 

15

Risk Free Return

 

 

8

Rashid Ali Ramay

03028104513

Rashid.ali02@nbp.com.pk

  • SML Linear Equation for the Required Return of any Stock A:

rA = rRF + (rM - rRF ) β A

rA =8 +(15-8)1.2

rA =16.4

Beta Stock A = σ A ρ AM / σ M

                            = 27*0.8/18

                           =1.2

 

SML Linear Equation for the Required Return of any Stock B:

rB= rRF + (rM - rRF ) β B

rB =8 +(15-8)0.777

rB =13.439

Beta Stock B = σ B ρ BM / σ M

                            = 28*0.5/18

                           =0.777

Rashid Ali Ramay

03028104513

Rashid.ali02@nbp.com.pk

 

  • Declare yourself either a risk taker investor or risk averse investor

I am a risk averse investor.

Rashid Ali Ramay

03028104513

Rashid.ali02@nbp.com.pk

 

  • Considering your risk appetite (either risk taker or risk averse) you are required to suggest which Stock should be selected. Provide a reason to support your selection (in bullet form). Your selection should be based on your risk appetite assumption i.e. first declare yourself as either risk taker or risk averse investor and then select stock based on calculations in part 1

Answer

  • After the study of market risk and diversification of risk I would like to choose stock’s B Because correlation coefficient is smaller than stock’s A

Gdb Solution Mgt201
Q1.page 107
Stock A S.D=27%
Ra=Rf +Ba (Rm-Rf)
=8%+0.8 %( 15%-8%)
=8%+0.8 %( 7%)
=8%+5.6%
=13.6%
Stock B S.D=28%
Ra=Rf + Ba ( Rm - Rf)
=8%+0.5 %( 15%-8%)
=8%+0.5 %( 7%)
=8%+3.5%
=11.5%
Q2. Risk taker investor
Q3.
Lower returns are usually associated with lower risk investments. Higher potential returns are associated with investments of higher risk,
So as a investors expect to be compensated for taking on additional risk on stock B because Risk taker acquire investments of higher risk with a lower expected return.


Note: if you found any mistake then correct ur self I m not responsible inc case of zero marks

100 % correct gdb solution mgt 201 By nimra

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