Problem 1 (20 points)

Consider the following table which gives a security analysts expected return on two stocks for two particular market returns:

Market Return Aggressive stock	Defensive stock
5% 2%	3.5%
20% 32%	14%

1. What are the betas of the two stocks? (5 points)

2. What is the expected return on each stock if the market return is equally likely to be 5% or 20%? If the T-bill rate is 8%, and the market return is equally likely to be 5% or 20%, what will be the slope of the SML for this economy. (5 points)

3. What are the alphas of each of these stocks?

What hurdle rate (or, required rate of return) should be used by the management of the aggressive firm for a project with the risk characteristics of the defensive firms stock?