The probability distribution and expected return on Stock A and B are provided below: State of economy Probability Return on stock Stock A Stock B 1…
BBS Fundamentals of Investment · 2079 · Solved Question with Answer
The probability distribution and expected return on Stock A and B are provided below:
| State of economy | Probability | Return on stock | |
| Stock A | Stock B | ||
| 1 | 0.30 | -5% | 20% |
| 2 | 0.40 | 10 | 15 |
| 3 | 0.30 | 15 | -10 |
Assume that an investor has Rs. 500,000 to invest, which he/she invests dividing equally in stock A and B.
a. What are the expected returns and standard deviations of each stock?
b. What are the covariance and correlation coefficient between returns from Stock A and B?
c. What are the portfolio return and standard deviation of the portfolio?
d. Do you prefer to hold Stock A or B or the Portfolio? Explain.
e. Suppose risk-free rate is a 4 percent, market return is 10 percent, and Stock A and B have beta coefficients of 0.5 and 1.1, respectively. Are these stocks fairly priced? Overvalued? Undervalued? Explain.