Chapter 13 Return, Risk, and Security Market Line All returns are annual returns unless indicated otherwise.

1. A stock has the following probability distribution: _________________________________________________________________ Demand for the Probability of This Rate of Return If This Companys Products Demand Occurring Demand Occurs __________________________________________________________________

Weak 0.05 0.25 (or 25%) Below Average 0.20 0.10 (or 10%) Average 0.50 0.15 (or 15%) Above Average 0.15 0.25 (or 25%) Strong 0.10 0.30 (or 30%) __________________________________________________________________ Calculate the stocks expected return, variance of returns, standard deviation of returns, and coefficient of variation of returns.

2. Use the following information for the problem. ____________________________________________________________________ State of Probability of Returns If State of Economy Occurs Economy State of Economy Stock S Stock T ____________________________________________________________________ Boom 0.30 0.20 (or 20%) 0.05 (or 5%) Normal 0.50 0.10 (or 10%) 0.07 (or 7%) Recession 0.20 0.05 (or 5%) 0.15 (or 15%) ________________________________________________________________________ a) Find the expected return of each stock. Use at least seven decimal places in computations of (b), (c) and (d) below to avoid significant rounding errors. b) Calculate the variance and standard deviation of returns of each stock. c) Compute the covariance and correlation of returns between the two stocks. d) Assume that you invest $40,000 in Stock S and $60,000 in Stock T. Find the expected return on the portfolio and the standard deviation of the portfolios return.