Answer:
a. The Sharpe ratio of Stock A is 0.23
The Sharpe ratio of Stock B is 0.92
b. The alpha of stock A is 1.4%
The alpha of stock B is -0.2%
c. If this stock will be mixed with the rest of the investor’s portfolio, Stock B should be included owing to higher return than stock A
Explanation:
a. In order to calculate the Sharpe ratio for each stock we woud have to use the following formula:
Sharpe Ratio of Stock
= (Rs-Rf)/σ s
where Rs = return on stock , σ s = standard deviation of stocks excess return, rf = risk-free rate
Sharpe ratio Stock A = ( 12-5)/31 = 0.23
Sharpe ratio Stock B = (16-5)/12 = 0.92
b. In order to calculate the alpha for each stock we woud have to use the following formula:
alpha = rate of return - risk free rate - β (market return - risk free rate)
alpha of stock A = 12-5-0.7(13-5)
= 1.4%
alpha of stock B = 16-5-1.4(13-5) = -0.2%
c. If this stock will be mixed with the rest of the investor’s portfolio, Stock B should be included owing to higher return than stock A
