Reference no: EM132038860
Stock Albatross has a risk-premium of 7 and a beta of 1.2. Stock Herring has a risk-premium of 6 and a beta of 0.9. Based on these numbers, you should prefer:
Herring because the reward-to-risk ratio is larger.
We need to know the variance before we can pick between the two.
Herring because the reward-to-risk ratio is smaller.
Albatross because the reward-to-risk ratio is smaller.
Albatross because we always want the stock with the highest expected return.
My calculation for the above question is
Assume Risk free rate as 5%
Expected Return for Albatross – 5% + 7x1.2 = 5% + 8.4% = 13.4%
Expected return for Herring – 5% + 6x0.9 = 5% + 5.4% = 10.4%
Reward-to-risk ratio of Albatross = expected return – risk free rate /beta = 0.134 – 0.05/1.2=0.07 = 7%
Reward-to-risk ratio of Herring = 0.104 – 0.05/0.9=0.06 = 6%
According to this we should prefer Albatross because the reward-to-risk ratio is higher.
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