a. (10 points) Stock A has a standard deviation of 50% and an expected return of 20%. Stock B has a standard deviation of 35% and an expected return of 15%. The correlation between the returns on the two stocks is 0.75. Consider a portfolio with a weight of on Stock A and on Stock B.

i. (5 points) What is the standard deviation of the portfolio?

ii. (5 points) What is the expected return of the portfolio?

b. (5 points) In 2019, Firm X had revenues of $200 million, costs excluding depreciation of $70 million, depreciation expenses of $20 million, interest expenses of $40 million and capital expenditures of $15 million. Net working capital was $35 million at the end of 2018 and $25 million at the end of 2019. The corporate tax rate is 20%. What was the firms unlevered cash flow in 2019?

Firm Ys debt consists of BB-rated bonds with a promised yield to maturity of 8.42%, a probability of default of 2.2% and an expected loss in default of 60%. What is the firms debt cost of capital?

You have the following information about the S&P500 index:

• Expected dividend yield for the next year (): 2.7%
• Expected perpetual dividend growth rate: 3.5%.

The S&P500 index is a proxy for the market portfolio, so we assume that the return on the market portfolio is equal to the return on the S&P500.

What is the expected return on the market portfolio implied by the Gordon model?