Given the following probability distributions for Stocks A and B, and the market portfolio, M:

Given the following probability distributions for Stocks A and B, and the market portfolio, M:

                       State   Probability      Return on A    Return on B                Return on M

                       Bust        0.15               -0.10              -0.18                              -0.15

                       Normal     0.60                0.09               0.12                              0.12

                       Boom     0.25                0.32               0.26                              0.25

You construct a 2-stock portfolio by investing $28,000 in Stock A and $12,000 in Stock B.

(a)       Compute the expected rate of return and variance of the 2-stock portfolio that is composed of Stocks A and B.

(b)       Given that the beta for stock A is 1.0197, compute the required (CAPM) rate of return on the 2-stock portfolio, given that the risk-free rate and the inflation rate are, respectively, 0.025 and 0.020. Explain your investment recommendation on the 2-stock portfolio according to the CAPM analysis.         

           (Hint: You need to compute the beta for Stock B, given that expected return and standard deviation for the market portfolio are, respectively, 0.1120 and 0.1229!)