1. Expected return on two stocks for two particular market returns:

Market Return Aggressive Stock Defensive Stock

5% 1% 8%

20% 25% 18%

a) What are the betas of the two stocks?

b) What is the expected rate of return on each stock if the market return is equally likely to be 5% or 20%?

c) If the T-bill rate is 3% and the market return is equally likely to be 5% or 20%, draw the SML for this economy.

d) Between aggressive and defensive stocks, which one is undervalued, which is overvalued, and why?