Question

Security A has an expected rate of return of 6%, a standard deviation of returns of 30%, a correlation coefficient with the market of -0.25, and a beta coefficient of -0.5. Security B has an expected return of 11%, a standard deviation of returns of 10%, a correlation with the market of 0.75, and a beta coefficient of 0.5. Which security is riskier

Answer 1

To determine which security is riskier, both expected rates of return and different risk measures must be examined. Security A has lower returns but higher volatility, while Security B has higher returns with lower volatility but more market sensitivity.

Step-by-step explanation:

To determine which security between A and B is riskier, one must consider both the expected rate of return and the risk (standard deviation of returns and beta coefficient). Security A has a lower expected return of 6% but a higher standard deviation (risk) of 30% and a negative beta, which implies it moves inversely to the market. Security B offers a higher expected return of 11%, with a much lower standard deviation of 10%, and a positive beta coefficient, indicating it moves with the market. Although Security A has a higher degree of uncertainty due to its larger standard deviation, it is less sensitive to market movements, which could be seen as less risky during market downturns. Conversely, Security B's higher correlation with the market could make it riskier in volatile markets despite its lower standard deviation. Therefore, defining 'risk' depends on whether one is more concerned with volatility or market sensitivity.

Answer 2

Security B

Step-by-step explanation:

The risk of an asset is measured by beta

Market beta is measured by 1. Securities that move more than the market have a beta greater than 1 .

Securities that moves less than the market have a beta less than 1

The beta of security A is less than that of security B. Thus, security B is more risky