Consider the following information:

State Probability A B

Boom 0.6 20% -5%

Bust 0.4 -10% 10%

1. What are the expected return and standard deviation of stock A and stock B?
2. If you invest 50% of your money in stock A and 50% of your money in stock B, what are the expected return and standard deviation for the portfolio as a whole (considering both states of the economy)?
3. Use the results of a-c to explain the benefit of diversification.