Question: It is estimated that stock A will return 10% if the economy is in normal condition next year, and the returns will be 16% and

It is estimated that stock A will return 10% if the economy is in normal condition next year, and the returns will be 16% and 3% respectively if the economy is in boom and bust conditions. The probability of the boom, normal, and bust economic conditions are estimated as 20%, 70%, and 10% respectively. What is the expected return of the stock is?

Q2. An investor plans create portfolio. One choice is to combine stocks A and B with 50% and 50% weight in each. If the return of A=20% and the return of B=16%, what will be the portfolio return? Another choice is to combine A with stock C. Stock C has the same return (16%) as B. However, the investor finds that the correlation coefficient between A and B is 0.7, while the correlation coefficient between A and C is -0.7. Which choice (A and B, or A and C) should the investor take and why?

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