Use the following information to evaluate whether or not you should buy stock A (assume you already own a well-diversified portfolio and are debating whether or not to add this stock to your portfolio). Show your work and justify your decision appropriately with financial theory.
Stock A S&P 500
Probability Return Probability Return
0.05 -80% 0.25 -20%
0.25 -20% 0.50 10%
0.50 14% 0.25 30%
0.20 60%
The current yield on the 10-year Treasury Note (risk-free rate) is 3.5%. The correlation between Stock A and the market is 0.60. Hint One – Remember that the S&P 500 represents the market and that you can use the two probability distributions above to get the expected return and standard deviation for both Stock A and for the market (round calculations to 2 decimal places in percentage terms). Hint Two – You will use the SML to get the required return and you will need to calculate beta from the data provided (round beta to two decimal places).