Reference no: EM132993698

Larry Jones is employed as an analyst at a major North American financial institution. Larry Jones is a recent graduate of Yorkville University and has a great reputation of being honest and ethical. An investment opportunity presents itself for Larry Jones to analyze. CN rail is in the Canadian Transportation industry. Bill Gates has taken a position in CN rail and now owns 14% of the outstanding shares. The current stock price is $140 per share. Market analysts have forecasted that if there is a recession next year the CN stock price will drop to $125, if the economy operates normally the stock price will be $150 and if the economy is expanding the stock price will reach $170. The likelihood of a recession is 30% the likelihood of an expanding economy is 30% and the likelihood of a normal economy is 40%. CN's beta is 0.85.

Problem 1: What is the Expected Return and Standard deviation of CN stock if we assume that the CAPM holds?

Problem 2: Larry Jones strongly believes that the Canadian rail industry will flourish and are looking at another rail company called CP rail. The correlation between CN and CP rail is .53. Larry Jones decides that a portfolio weighting of 70% in CN and 30% in CP rail is optimal. Further analysis shows that the Expected Return on CP rail is 12%, standard deviation is 15% and beta is .75 What is the Expected return, the Standard Deviation and the Beta of this portfolio? Finally, in a brief paragraph (200 - 400 words) explain the concept of diversification and why total risk in and of itself is not important to investors?