Problem 1. Two stocks, i and j have the following probability distributions (see table).
Probability Ri Rj
0.20 23% 8%
0.45 8 12
0.35 15 16
Calculate the expected returns, standard deviations and coefficient of variations for stocks i and j. Which stock would be preferred by the average investor? Explain why in your own words.
Problem 2. Calculate the return distribution of a portfolio, P, constructed of 60% in i and 40% in j.
Problem 3. Use the probability distribution in questions 2 above to calculate the expected return and standard deviation of the portfolio, P.
Problem 4. Use the expected returns of i and j to calculate the expected return on portfolio, P. Compare the answer in this question to the answer in question 3 above. What do you notice?
Problem 5. Assume that the risk-free interest rate is 3%, the expected return on the market is 8%, the beta of stock i is 1.50, and the beta of stock j is 1.8. Are i and j overpriced, underpriced or fairly priced?
Problem 6. Calculate the beta of portfolio, P. Given the beta of P and the information in question 5 above, is portfolio P overpriced, underpriced, or fairly priced?