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Calculate the expected return for each stock

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Question - You are considering investing in two stocks, Stock A and Stock B. Their returns have the following probability distributions over the next year:

State of the economy

Probability

Return of Stock A

Return of Stock B

Boom

0.3

20%

-5%

Average

0.5

15%

5%

Recession

0.2

5%

20%

Required -

a. Calculate the expected return for each stock.

b. Calculate the standard deviation of returns for each stock.

c. Compute the correlation coefficient of the two stocks.

d. If you were to buy only one of the two stocks, which stock would you buy? Why?

e. Suppose you decided to construct a portfolio with $40,000 invested in Stock A and $60,000 in Stock B.

(1) Determine the expected return of the portfolio.

(2) Determine the standard deviation of returns for the portfolio.

(3) How does the standard deviation of returns for the portfolio differ from the standard deviations of individual stocks? Comment on the effect of diversification.

Reference no: EM133108994

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