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By comparing both the stocks, the riskiest stock in this case is Reynolds. It has the highest return as well as higher standard deviation and the higher variance. If we compare both stocks, Reynolds is riskier than Hasbro in this case. The higher variance indicates higher chance that the actual return on Reynolds will deviate from the expected return.
At individual stock level, Reynolds fluctuates more than Hasboro as it has higher Standard Deviation and higher variance. After calculating the portfolio of both the stocks, it gives us a different picture. Looking at the numbers at portfolio level, Portfolio A which constitutes Reynolds still has a higher return(.587) but at a lower standard deviation (3.59) and variance (12.9), compared to Hasbro. This means that Reynolds when combined with S&P 500 is giving a higher return at the portfolio level but with a lower standard deviation and a lower variance when compared with the portfolio of S&P & Hasbro. It also means Reynolds is less risky than Hasbro when combined in a portfolio. Portfolio B (S&P+Hasboro) in this case seems more volatile than Portfolio A(S&P + Reynolds).We can also say that the variance which is measuring the risk involved was reduced by combining the stock in a portfolio.
Portfolio A (.99 S&P + .01 Reynolds)
Portfolio B (.99 S&P + .01 HASBRO)
Reynolds Beta =.7358 Hasbro Beta 1.4198
Calculating the Beta, Hasbro’s beta is more than 1, which means it’s more volatile than the market. We can also say its 42% more volatile than the market. Higher beta also offers a possibility of a higher rate of return but also with higher risk. Reynolds has a beta of .74, which means is less volatile than the market.
Portfolio A (S&P + Reynolds) Beta = .9974 Portfolio B (S&P + Hasbro) Beta = 1.0042 When we add the stocks of Reynolds and Hasbro to the portfolio, the Beta changes to almost similar or close to market. Basically, we can see that having a stock in a portfolio is better here as stock like Reynolds, which was moving less than the market is now very close to the market movement at .9974. Furthermore, Hasbro which was moving above the market level is now moving almost with the market at 1.0042. *Please see the attached excel file for calculations.
We can’t figure out the riskiness of the stock by just looking at the expected return. In the case of individual stock, Reynolds at 1.87 is giving a higher return compared to Hasbro at 1.18. We wouldn’t know the riskiness unless we look at the standard deviation or the variance of the stock. By comparing the two, Reynolds has a higher variance and standard deviation and will be more risky. When combined with portfolio, we see the variance has changed. Reynolds, which was more risky with higher variance individually, when combined with portfolio, has a lower variance than Hasbro. On the other hand, Hasbro, which had considerably less return and variance individually, when combined in a portfolio, has more volatility, hence becoming more risky.
Alex Sharpe should invest in Portfolio A, consisting of Reynolds and S&P500. Portfolio A gives higher return with lower risk. The standard deviation and the variance are both lower for portfolio A which means Alex Sharpe will get better returns at a much lower risk as compared to Portfolio B.