Reference no: EM133111200
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!)
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