1. Consider the following possible returns on Apple's stock, Microsoft's stock, and the market portfolio over the next year:

State of economy	Probability of state occurring	Return on Apple	Return on Microsoft	Return on market
Recession	0.2	-6%	20%	-5%
Normal	0.5	10%	8%	8%
Boom	0.3	18%	-20%	12%

1. What are the expected returns on Apple, Microsoft, and the market?
2. What are the standard deviations of returns on Apple, Microsoft, and the market?
3. What is the correlation between the returns on the two stocks?
4. What are the betas of the two stocks?
5. Calculate the expected return and standard deviation of a portfolio that is composed of 40% of Apple and 60% of Microsoft.
6. What do your answers in parts (b), (c), and (e) imply about diversification?
7. A broker has advised you not to invest in Microsoft because it has a higher standard deviation. Is the brokers advice sound for a risk-averse investor like yourself? Why or why not?