Consider the following situation:

State of Economy

Probability of State of Economy

Returns if State Occurs

Stock A

Stock B

Boom

40%

30%

20%

Average

40%

10%

10%

Recession

20%

-30%

10%

The expected return on the market portfolio is 10% and the US Treasury bill yields 2%. The capital market is currently in equilibrium.

(5 points) Which stock has the most systematic risk? Provide all the steps and equations.

(5 points) Which stock has the most unsystematic risk? Explain why. Provide all the steps and equations.

(10 points) What is the standard deviation of a portfolio which is comprised of $8,400 invested in stock A and $3,600 in stock B?