Ravi, a fund manager working for a private equity firm, isconsidering including the following stocks in the firm?sportfolio:

He plans to invest 40% of the portfolio funds in stock RST andthe balance equally between VVR and BAB. Beta of stock VVR is 0.15higher than RST.

The firm?s in-house economist anticipates the probability ofboom, normal and recession to be 25%, 40% and 35% respectively. Theyield on long term government securities is 3% per year.

(a) Calculate the expected return and standard deviation foreach stock. (6 marks)

(b) Calculate the expected return, expected risk premium andstandard deviation for the portfolio. (4 marks)

(c) Interpret your answer for part (a) and (b) and advise Ravion his asset allocation plan for the portfolio. (6 marks)

(d) Compute the expected market risk premium assuming capitalasset pricing model holds. (4 marks) (e) Explain whether stock RSTor stock VVR is riskier. (5 marks)

Rate of Return State of Probability Economy Stock RST 0% 6% 15% Stock VVR 25% 40% 35% Boom Normal Recession 20% 12% -4% Stock BAB 40% 15% -26%

Probability 25% 40% 35% State of Economy Boom Normal Recession Stock RST 0% 6% 15% Rate of Return Stock VVR 20% 12% -4% Stock BAB 40% 15% -26%