The investment opportunities have these characteristics:

The investment opportunities have these characteristics:

	Mean Return	Standard Deviation
Stocks	18.40%	13.40%
Bonds	12.00%	4.29%
Portfolio	16.48%	8.09%

The best choice depends on the degree of your aversion to risk. Nevertheless, we suspect most people would choose the portfolio over stocks since the portfolio has almost the same return with much lower volatility. This is the advantage of diversification.

A stock will provide a rate of return of either −27% or +35%.

a.	If both possibilities are equally likely, calculate the expected return and standard deviation. (Do not round intermediate calculations. Round your answers to 1 decimal place.)

Expected return	%
Standard deviation	%

b.	If Treasury bills yield 4% and investors believe that the stock offers a satisfactory expected return, what must the market risk of the stock be?

Market risk

$

Explanation:

a.

The expected rate of return on the stock is 4.0%. The standard deviation is 31.0%.

b.

Because the stock offers a risk premium of zero (its expected return is the same as the expected return for Treasury bills), it must have no market risk. All the risk must be diversifiable, and therefore of no concern to investors.