Question: Problem 12-14 Expected Returns (LO2) Consider the following two scenarios for the economy and the expected returns in each scenario for the market portfolio, an

Problem 12-14 Expected Returns (LO2)

Consider the following two scenarios for the economy and the expected returns in each scenario for the market portfolio, an aggressive stock A, and a defensive stock D.

Scenario Rate of Return
Market Aggressive Stock A Defensive Stock D
Bust 10% 12% 3%
Boom 20 30 10

Required:

  1. Find the beta of each stock.
  2. If each scenario is equally likely, find the expected rate of return on the market portfolio and on each stock.
  3. If the T-bill rate is 5%, what does the CAPM say about the fair expected rate of return on the two stocks?
  4. Which stock seems to be a better buy on the basis of your answers to (a) through (c)?

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