Question 2 (25 marks)

The expected returns under different states of the economy of the KR, an airline company, are listed below:

Market return (): 10%

Risk-free rate (): 2%

Based on all the above available information and assumed that CAPM is hold,

a)

i. compute the stock expected return of KR.

ii. compute the stock standard deviation of KR.

iii. compute the stock beta of KR.

b) If you like to form an equally weighted 2-asset portfolio comprising KR and Stock A to achieve a portfolio beta equal to the overall market, compute the beta and the expected return of Stock A.

c) Given the following events happen, briefly describe how they might affect KRs stock price (within 50 words for each below sub-sessions):

i) The government announces that the unemployment rate is unexpectedly high.

ii) The short-term interest rates rise unexpectedly.

State of Economy KR's stock return Recession Normal Boom Probability of State of Economy 0.5 0.4 ? 6% 10% 14%