(b) Mrs Daisy is considering two securities, A and B, and the relevant information is given below:

State of Economy Probability Return on Security A (%) Return on Security B (%)

Bear 0.6 3.00% 6.50%

Bull 0.4 15.00% 6.50%

1. Calculate the expected returns and standard deviations of security A and security B. (5 marks)

2. Explain how diversification can reduce the unsystematic risk of a given portfolio? (3 marks)