Consider the following two scenarios for the economy and the expected returns in each scenario for the market portfolio, an aggressive stock A, and a defensive stock D.

Rate of Return

Aggressive Defensive

Scenario Market Stock A Stock D

Bust -7 % -9 % -5 %

Boom 29 35 20

Required:

a. Find the beta of each stock.

b. If each scenario is equally likely, find the expected rate of return on the market portfolio and on each stock.

c. If the T-bill rate is 5%, what does the CAPM say about the fair expected rate of return on the two stocks?

d. Which stock seems to be a better buy on the basis of your answers to (a) through (c)?