Question

You expect General Motors (GM) to have a beta of 1.5 over the next year, and the beta of Exxon Mobil (XOM) to be 1 over the next year. Also, you expect the volatility (i.e. the standard deviation of returns) of GM to be 40%, and that of XOM to be 60% over the next year. Which stock has more systematic risk? Which stock has more total risk?

Answer 1

Answer:

a. General Motors (GM)

b. Exxon Mobil's (XOM)

Explanation:

a. Which stock has more systematic risk?

Systematic risk refers to risk that is inherent to the market as a whole. It is measured by beta.

When;

1. beta > 1, it implies an investment has more systematic risk than the market

2. beta < 1, it implies the investment has less systematic risk than the market.

3. beta = 1, it implies the investment and the market has the same systematic risk as the market.

Based on the above, a beta of 1.5 implies that General Motors' (GM) stock has more systematic risk than Exxon Mobil's (XOM) which has a beta of 1.

b. Which stock has more total risk?

Total risk is the addition of systematic and unsystematic risks. Contrary to systematic risk that relates to the market as a whole, Unsystematic risk affects or relates to particular group of securities or an individual security.

Standard deviation is the addition of both systematic and unsystematic risks, and therefore a measure of the total risk.

Since 60% standard deviation of Exxon Mobil (XOM) is greater than 40% standard deviation of General Motors (GM), it therefore implies that Exxon Mobil's (XOM) stock has more total risk.