There are two stocks in the market, stock A and stock B. The price of stock A today is $65. The price of stock A next year will be $53 if the economy is in a recession, $73 if the economy is normal, and $85 if the economy is expanding. The probabilities of recession, normal times, and expansion are 0.2, 0.6, and 0.2, respectively. Stock A pays no dividends and has a beta of 0.68. Stock B has an expected return of 13 percent, a standard deviation of 34 percent, a beat of 0.45, and a correlation with stock A of 0.48. The market portfolio has a standard deviation of 14 percent.
Assume the CAPM holds.
a) What are the expected returns and standard deviation of stock A?
b) If you are a typical, risk-averse investor with a well-diversified portfolio, which stock would you prefer?
c) What are the expected return and standard deviation of a portfolio consisting of 60 percent of stock A and 40 percent of stock B?
d) What is the beta of the portfolio in (c)?
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There are two stocks in the market, stock A and stock B. The price of stock A today is $65. The pric...
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