2. (Do not use excel)You are considering an investment in Stock A and Stock B. Your security analyst has estimated the returns on these two stocks as follows:

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State of Probability of Return on Return on Economy State Occurring Stock A Stock B

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Bust 0.10 0.10 (or 10%) 0.05 (or 5%) Normal 0.60 0.15 (or 15%) 0.10 (or 10%) Boom 0.30 0.25 (or 25%) 0.40 (or 40%)

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a) Find the expected return on each stock.

Use at least six decimal places when computing (b), (c), and (d) below to minimize rounding errors.

b) Compute the variance and standard deviation of returns of each stock. c) Find the covariance and correlation between the returns on Stock A and Stock B. d) Assume that you form a portfolio consisting of Stock A and Stock B. You invest $3,000 in Stock A and $7,000 in Stock B. i) Find the weight of each stock in the portfolio. ii) Find the expected return and standard deviation of returns on the portfolio consisting of Stock A and Stock B.