There are two stocks in the market, stock A and stock B. The price of stock A today is $75.

There are two stocks in the market, stock A and stock B. The price of stock A today is $75. The

price of stock A next year will be $63 if the economy is in a recession, $83 if the economy is

normal, and $96 if the economy is expanding. The probabilities of recession, normal times and

expansion are.2, .6, and .2 respectively. Stock A pays no dividends and has a correlation of .8

with the market portfolio. Stock B has an expected return of 13 percent, a standard deviation of

34 percent, a correlation with the market portfolio of .25, and a correlation with stock A of .48.

The market portfolio has a standard deviation of 18 percent. Assume the CAPM holds.

a. If you are a typical, risk averse investor with a well-diversified portfolio, which stock

would you prefer? Why?

b. What are the expected return and standard deviation of a portfolio consisting of 70

percent of stock A and 30 percent of stock B?

c. What is the beta of the portfolio in part (b)?