Consider the following information about Stock I and II The market risk premium

Consider the following information about stock i and

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#5: Consider the following information about Stock I and II:The market risk premium is 8 percent, and the risk-free rate is 4 percent. Which stock has the most systematic risk? Which one has the most unsystematic risk? Which stock is “riskier”? Explain.State of EconomyProbability of State of EconomyRate of Return if State OccursStock IStock IIRecession0.250.11-0.40Normal0.500.290.10Irrational exuberance0.250.130.56 8
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Although Stock II has more total risk than I, it has much less systematic risk, since its beta is much smaller than I’s. Thus, I has more systematic risk, and II has more unsystematic and more total risk. Since unsystematic risk can be diversified away, I is actually the “riskier” stock despite the lack of volatility in its returns. Stock I will have a higher risk premium and a greater expected return. 10 Stock I Stock II Systematic Risk 2.06 0.625 Total Risk ? 0.0853 0.340 Total Risk Lower Higher Systematic Risk More Less Unsystematic Risk Less More
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