1. Assume probability of state of economy to be equal, that is 1/3 for each state of economy.

2. Construct an equally weighted portfolio of Stock A and Stock B (50% of Stock A and 50% of Stock B). Determine the expected return and standard deviation of such a portfolio.

3. Compare the standard deviation of this portfolio to the average standard deviation of Stock A and Stock B. Which is lower? Explain.

4. Assume return on Stock A has a correlation coefficient of 0.70 with the market portfolio, S&P500, and return on Stock B has a correlation coefficient of 0.45 with the market portfolio, S&P500, and that the return of S&P 500 has a standard deviation of 25%. Determine the beta of Stock A and the beta of Stock B.