1: Consider the simple two-period model. Let today be period zero and tomorrow be period 1. Assume that today's price of AAA stock is $23 and tomorrow price could be $28 or $21 with equal probabilities. Answer the following questions: a. (1 mark) What is the expected rate of return on AAA stock? b. (2 marks) What is the risk of AAA stock? c. (2 marks) Assume that you want to allocate your initial wealth of $1,000 on a portfolio that consists of AAA stock and of BBB stock, with equal weights to each stock. If BBB stock is currently traded at $24 has an expected rate of return of 4 percent, variance of 900 and covariance between the two stocks is 25. Find the expected rate of return on this portfolio and its risk.

2: You want to invest in a portfolio that consists of two stocks: AAA and BBB. According to your analysis, you are expecting three states of nature: recession, steady and expansion, with probabilities of 0.2, 0.5 and 0.3 respectively. Current AAA stock price is $50, while BBB stock is $40. The following table show the analysts' prediction for the price in each state: State of Economy Probability AAA stock BBB STOCK Recession 0.2 $51 $41 Steady 0.5 $54 $42 Expansion 0.3 $58 $47 Suppose you decided to construct a portfolio, , such that 60% of your wealth is allocated to AAA stock and 40% to BBB stock. Given this allocation, solve the following two questions: a. (1 mark) Compute the expected rate of return on . b. (2 marks) Compute the portfolio's measure of risk.