John is thinking about investing his money in the stock market. He has the following three stocks in mind: stock A, B, and C. He knows that the economy is expected to behave according to the following table. He believes that the likelihood of each scenario is identical (all states of nature have equal probabilities. He also knows the following about his stocks:
State of the Economy RA RB RC
Depression -20% 5% –5%
Recession 10% 20% 5%
Normal 30% -12% 5%
Boom 50% 9% -3%
E) Calculate the expected return of a portfolio with equal investments in stock A and in the portfolio (with stock B&C)?
F) What is the total risk of this portfolio?
G) How can you tell that you have improved your risk-return tradeoff relative to the individual investments in A, B, and C?