There are two stocks in the market, Stock A and Stock B. The price of Stock A today is $65. The price of Stock A next year will be $53 if the economy is in a recession, $73 if the economy is normal, and $85 if the economy is expanding. The probabilities of recession, normal, and expansion are 0.2,0.6, and 0.2 respectively. Stock A pays no dividends and has a beta of 0.68. Stock B has an Expected return of 13%, a standard deviation of 34%, a beta of 0.45 and a correlation with stock A of 0.48. The market portfolio has a standard deviation of 14%. Assume the CAPM holds.
A. What are the expected return and standard Deviations of Stock A?
B. If you are a typical, risk-averse investor with a well diversified portfolio, which stock would you prefer and why?
C. What are the expected return and Standard deviations of a portfolio consisting of 60% stock A and 40% Stock B?
D. What is the beta of the portfolio in (c)?
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