1. Consider the following possible returns on stock A, stock B, and the market portfolio over the next year:

State of economy	Probability of state occurring	Return on stock A	Return on stock B	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 stock A, stock B, and the market?
2. What are the standard deviations of returns on stock A, stock B, 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 A and 60% of B.
6. What do your answers in parts (b), (c), and (e) imply about diversification?
7. A broker has advised you not to invest in stock B because it has a higher standard deviation. Is the brokers advice sound for a risk-averse investor like yourself? Why or why not?