4. Given the following probability distributions for Stocks A and B, and the market portfolio, M:

State Probability Return on A Return on B Return on M

Boom 0.2 0.10 0.45 0.20

Normal 0.5 0.15 0.20 0.12

Bust 0.3 0.20 -0.10 0.0

You construct a 2-stock portfolio by investing $28,000 in Stock A and $12,000 in Stock B.

(a) Compute the expected rate of return and variance of the 2-stock portfolio that is composed of Stocks A and B.

(b) Given that the expected return and the variance of the market portfolio are 0.10 and 0.0052, respectively, compute the beta and the required (CAPM) rate of return on the 2-stock portfolio. Assume that the risk-free rate is 2%. Explain your investment recommendation on the 2-stock portfolio according to the CAPM analysis.