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 %















































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%




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





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:






Find alphas:

A: Alpha =

B: Alpha =


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