come on in.
Seriously though… I just finished up and this q annoys me. Kaskin, Inc., stock has a beta of 1.2 and Quinn, Inc., stock has a beta of 0.6. Which of the following statements is most accurate? A) The expected rate of return will be higher for the stock of Kaskin, Inc., than that of Quinn, Inc. B) The stock of Quinn, Inc., has more systematic risk than that of Kaskin, Inc. C) The stock of Kaskin, Inc., has more total risk than Quinn, Inc. D) For a risk averse investor, the stock of Kaskin, Inc., is more desirable than the stock of Quinn, Inc.
B?
I pick B too. A - required return will be higher C - partly correct I guess but too vague to be the right answer? D - flat out wrong
Unless I’m totally wrong on my PM stuff (I haven’t touched LII stuff yet), I think it’s A.
I think A too.
ding “Your answer: B was incorrect. The correct answer was A) The expected rate of return will be higher for the stock of Kaskin, Inc., than that of Quinn, Inc. Beta is a measure of systematic risk. Since only systematic risk is rewarded, it is safe to conclude that the expected return will be higher for Kaskin’s stock than for Quinn’s stock.” Now I have had a couple beers at my desk tonight, so I fell into the trap, flipped the Kaskin and Quinn betas and went with the B… but still, I thought about A and well I just couldn’t convince myself it was 100% accurate. If the rfr was say 6% and the expected market return was say 4%, what would the expected return of these two Co’s be then? Thank you.
Oh answer B is dirty…
Based on your scenario Slouiscar Kaskin: 10.8% Quinn: 9.0%
Yes B was uncalled for. Black Swan Wrote: ------------------------------------------------------- > Based on your scenario Slouiscar > > Kaskin: 10.8% > Quinn: 9.0% study break. Kaskin E® = 0.06 + 1.2*(0.04 - 0.06) = 3.6% Quinn E® = 0.06 + 0.6*(0.04 - 0.06) = 4.8% and yes Quinn E® > Kaskin E®. I don’t know where that 9.0% came from! 8.4 maybe I could let you slide…sorry
I am getting Kaskin: 10.8% Quinn: 8.4% EDIT: My formula is wrong here. See my post below. A. slouis, Are you thinking that A wouldn’t hold if the expected return for the market was negative? If you are going that way I don’t think that would hold under CAPM (haven’t looked at PM yet for level II though). There has to be a positive risk premium for market risk (systematic) risk in the long run or markets don’t work in a CAPM world.
slouiscar Wrote: ------------------------------------------------------- > Yes B was uncalled for. > > Black Swan Wrote: > -------------------------------------------------- > ----- > > Based on your scenario Slouiscar > > > > Kaskin: 10.8% > > Quinn: 9.0% > > study break. > > Kaskin E® = 0.06 + 1.2*(0.04 - 0.06) = 3.6% > Quinn E® = 0.06 + 0.6*(0.04 - 0.06) = 4.8% > > and yes Quinn E® > Kaskin E®. > > I don’t know where that 9.0% came from! 8.4 maybe > I could let you slide…sorry Oh yeah, I had the formula wrong for E®. I think I can stand by the rest of my post though. You aren’t going to have a negative risk premium for systematic risk. Please correct me if you know different. Something would have to compensate you for holding those risky assets!
I agree. Who would invest in something with a lower expected return and higher risk? I think it is a key assumption that investors are risk adverse and seek more expected return and less risk.
No other good answer either Kaskin, Inc., stock has a beta of 1.2 and Quinn, Inc., stock has a beta of 0.6. Which of the following statements is most accurate? A) The expected rate of return will be higher for the stock of Kaskin, Inc., than that of Quinn, Inc. Best answer. B) The stock of Quinn, Inc., has more systematic risk than that of Kaskin, Inc. Of course not true, lower beta C) The stock of Kaskin, Inc., has more total risk than Quinn, Inc. Can’t know this as beta is just a measure of systematic risk, not total (business, operating, whatever) D) For a risk averse investor, the stock of Kaskin, Inc., is more desirable than the stock of Quinn, Inc. We don’t know which one has more total risk, but absent more information you would have to rule this out.
Agreed^ I misread B first pass. I guess I just couldn’t stomach the defeat. Flip the names and B makes the most sense IMO. Ans A just seemed a little too, well, rigid. I mean, I agree you have to be compensated for systematic risk and this may just be the fri buzz talking but say I am in Indonesia and the rfr is 14% and I expect the Jakarta Composite Index to return 10% next year? I am considering some Alfa Retailindo for my account w/ a beta of 1.3… I mean are those expectations plausible? I mean it is an expected return, can’t the mkt return be expected to be low? I guess it sounds silly now as I type it.
slouiscar Wrote: ------------------------------------------------------- > Agreed^ > > I misread B first pass. I guess I just couldn’t > stomach the defeat. Flip the names and B makes > the most sense IMO. Ans A just seemed a little > too, well, rigid. I know what you mean. If B was flipped I would pick it too. > > I mean, I agree you have to be compensated for > systematic risk and this may just be the fri buzz > talking but say I am in Indonesia and the rfr is > 14% and I expect the Jakarta Composite Index to > return 10% next year? I am considering some Alfa > Retailindo for my account w/ a beta of 1.3… I > mean are those expectations plausible? I mean it > is an expected return, can’t the mkt return be > expected to be low? I guess it sounds silly now > as I type it. Depends on your time frame. If you are talking about 1 year then sure you are going to have a negative risk premium, but any length of time it can’t hold up or stocks would price themselves so it didn’t. I don’t know if you ever have an EXPECTED negative market risk premium. Any one individual could have that expectation, but not the market as a whole. If that was the case there would be no buyers of stocks…prices would drop…bring back the positive market premium…blah blah markets work pretty well, etc. I do remember a question on the sample CFA exams last year that where you had to use the 10 yr note as the RFR because we were evaluating a market premium over a 10 yr time period…so it could hold if you were using the 3 mo T-bill as your RFR. I don’t know I am just talkin crap now.
Ok, my bad, I thought by return of market you meant market premium, and I did it in my head as I ran out the door for a minute (I’m calculator / excell dependent) so that explains the minor miscalc on the second return. But I think it was discussed earlier this week and Joey mentioned that the CAPM assums a positive risk premium. Using the risk adverse investor assumption, I think it would violate a basic foundation of ethics if investors started demanding a lower return on the market when they could get a higher return on a risk free investment. Also, Slouis, I didn’t mean to insult you by breaking out he CAPM which I realized later might have been the way that seemed. You’re definitely stronger than me in the quant department based on some of your other posts I’ve seen. I actually made the same mistake of flipping the betas and had to take a second look before I posted A. I think you just made the mistake of overthinking it, which is one of my gripes with the overall CFA tests. One second they present a basic concept then screw you on a wording detail (especially in ethics) then on the next question, they present another basic concept and overlook exceptions that cause you to answer wrongly if you overthink it.
Sorry Black Swan, I wasn’t trying to pick on you. When I said “B was uncalled” for I was refering to choice B where they made what I felt was the most accurate statement but flipped the names just to be a smarta##. I didn’t feel insulted or anything like that. I agree with you both as I read this again this morning with a clear head.