Chartered Financial Analyst Level 1

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Explanation:

The nonsystematic risk (idiosyncratic risk) for each stock is calculated as follows:

Stock 1: Nonsystematic variance = (0.17)^2 - (0.9)^2(0.1)^2 = 0.0208
Stock 2: Nonsystematic variance = (0.18)^2 - (1.1)^2(0.1)^2 = 0.0203
Stock 3: Nonsystematic variance = (0.16)^2 - (1.2)^2(0.1)^2 = 0.0112

Stock 1 has the highest nonsystematic variance, indicating the highest nonsystematic risk. Nonsystematic risk is diversifiable and specific to individual companies or industries, unlike systematic risk, which affects the entire market. Investors are not compensated for bearing nonsystematic risk because it can be mitigated through diversification.

Explanation:

The nonsystematic risk (idiosyncratic risk) for each stock is calculated as follows:

Stock 1: Nonsystematic variance = (0.17)^2 - (0.9)^2(0.1)^2 = 0.0208
Stock 2: Nonsystematic variance = (0.18)^2 - (1.1)^2(0.1)^2 = 0.0203
Stock 3: Nonsystematic variance = (0.16)^2 - (1.2)^2(0.1)^2 = 0.0112

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An analyst evaluates three stocks with the following characteristics:

Stock 1: Beta = 0.9, Standard Deviation of Returns = 17%

Stock 2: Beta = 1.1, Standard Deviation of Returns = 18%

Stock 3: Beta = 1.2, Standard Deviation of Returns = 16% If the standard deviation of market returns is 10%, which stock has the highest nonsystematic risk?

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Stock 1

Stock 2

Stock 3