Problem 1: Risk, return, and price adjustments (3 points) Say everyone agrees st
ID: 2816327 • Letter: P
Question
Problem 1: Risk, return, and price adjustments (3 points) Say everyone agrees stock A is riskier than stock B, but they have the same expected return (a) Which would you prefer to buy? Why? (i) Stock A. (ii) Stock E. b) In order for someone to want to hold the stock you don't like, what would have to happen to the price of that stock, assuming the other stock remains unchanged? Why? (i) Price goes up (ii) Price goes down. (c) If the price changes as described in (b), what happens to expected returns? Why? (i) Expected returns go up (i) Expected return go down.Explanation / Answer
a. Choose stock B. Since the expected return is the same, choose the less riskier stock.
b. Price goes down. If the price goes down, the investor continues to hold the stock even if they don't like.
c. Expected return go down. Expected return is an estimation of future return. So, if price goes down, expected return also goes down.