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Question 3. A bank has two loans of equal size outstanding, A and B, and the bank has identified the returns they would earn
Question 3. A bank has two loans of equal size outstanding, A and B, and the bank has identified the returns they would earn in two different states of nature, 1 and 2, representing default and no default, respectively. Security A Security B State 1 0.02 0.00 State 2 0.14 0.18 If the probability of state 1 is 0.2 and the probability of state 2 is 0.8, calculate (i) the expected return of each security, (ii) the expected return on the portfolio in each state, and (iii) the expected return on the portfolio. [6 marks]
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