a) The following predictions have been made regarding the economic states, share A and share B.

State Probability of the state Share A rate of return Share B rate of return

Recession 0.10 -0.20 0.30

Normal 0.50 0.10 0.20

Boom 0.40 0.70 0.50

Calculate the expected return and standard deviation for share A

Calculate the expected return and standard deviation for share B.

b) Assume you observe the following situation:

Security Beta Expected Return

A 1.2 13%

B 0.6 10%

The Treasury Bill rate is 5 percent.

Which one of the two securities is overvalued relative to the other?

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