Stock A has a standard deviation of return of 40%; Stock B 30%.  Stock A has a return correlation coefficient with the S&P500 of 0.32; Stock B 0.85.  S&P 500 has an expected return of 12.5% and a standard deviation of return of 20%, while T-bill rate is 3.8%.  

1.    What is the un-diversifiable risk of Stock A? Stock B? Which stock has greater risk?

2.   What is the beta of Stock A? Stock B?

3.   What is the risk premium for S&P500?  Stock A? Stock B?

4.   What is the required rate of return for Stock A? Stock B?

Stock A is expected to pay a dividend of $1.25 in a year and is expected to have a price of $25 in a year.  Stock B is expected to pay a dividend of $0.50 each year for the next three years and is expected to have a price of $30 in three years.

1.   Determine the current value of Stock A.  (Hint: find the present value of future cash flows using the required rate of return derived from above for Stock A.)

2.   Determine the current value of Stock B. (Hint: find the present value of future cash flows using the required rate of return derived from above for Stock B.)

3.   If Stock A has an expected return of 8.5%, will you invest in Stock A?  Why or why not?

4.   If Stock B has an expected return of 15%, will you invest in Stock B?  Why or why not?

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