# Consider the following scenario analysis for stocks a and b and for

Question:Risk and Return

1.Consider the following scenario analysis for Stocks A and B and for the market portfolio (M)

 Rate of Return State of Economy Probability of State Stock A % Stock B % Market % Boom 0.1 30 45 33 Good 0.6 12 10 15 Average 0.2 1 -15 -5 Bust 0.1 -20 -30 -9

a)      Calculate the expected rate of return on each stock and the market?                        (15)

Stock A:

Expected Rate =  = 30*0.1+12*0.6+1*0.2-20*0.1

= 8.4%

Stock B:

Expected Rate =  = 45*0.1+10*0.6-15*0.2-30*0.1

= 4.5%

Market:

Expected Rate =  = 33*0.1+15*0.6-5*0.2-9*0.1

= 10.4%

b)      Find the standard deviation of returns for each asset?           (15)

Stock A:

Standard deviation  =

= 208.2

Stock B:

Standard deviation  =

= 393

Market:

Standard deviation  =

= 246.6

2. The risk free rate is 3% and the betas of the stocks are:

Stock               Beta

A                     1.20

B                     0.70

Are the stocks fairly priced?

Find required returns:

A:

B:

Find alphas:

A: Alpha =

B: Alpha =

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