# Question: There are two stocks in the market Stock A and

There are two stocks in the market, Stock A and Stock B. The price of Stock A today is $75. The price of Stock A next year will be $64 if the economy is in a recession, $87 if the economy is normal, and $97 if the economy is expanding. The probabilities of recession, normal times, and expansion are .2, .6, and .2, respectively. Stock A pays no dividends and has a correlation of .7 with the market portfolio. Stock B has an expected return of 14 percent, a standard deviation of 34 percent, a correlation with the market portfolio of .24, and a correlation with Stock A of .36. The market portfolio has a standard deviation of 18 percent. Assume the CAPM holds.

a. If you are a typical, risk-averse investor with a well-diversified portfolio, which stock

would you prefer? Why?

b. What are the expected return and standard deviation of a portfolio consisting of 70 percent of Stock A and 30 percent of Stock B ?

c. What is the beta of the portfolio in part (b)?

a. If you are a typical, risk-averse investor with a well-diversified portfolio, which stock

would you prefer? Why?

b. What are the expected return and standard deviation of a portfolio consisting of 70 percent of Stock A and 30 percent of Stock B ?

c. What is the beta of the portfolio in part (b)?

## Answer to relevant Questions

Assume Stocks A and B have the following characteristics:The covariance between the returns on the two stocks is .001. a. Suppose an investor holds a portfolio consisting of only Stock A and Stock B. Find the portfolio ...You own stock in the Lewis-Striden Drug Company. Suppose you had expected the following events to occur last month: a. The government would announce that real GNP had grown 1.2 percent during the previous quarter. The ...Suppose stock returns can be explained by a two-factor model. The firm-specific risks for all stocks are independent. The following table shows the information for two diversified portfolios: If the risk-free rate is 4 ...What factors determine the beta of a stock? Define and describe each.Suppose your company needs $20 million to build a new assembly line. Your target debt–equity ratio is .75. The flotation cost for new equity is 7 percent, but the flotation cost for debt is only 3 percent. Your boss has ...Post your question