Stock A

Probability of outcome. Return

.2 .04

.3 .01

.1 .08

.4 .05

Stock B

Probability of outcome Return

.15 .02

.25 .04

.3 .03

.3 .03

(a) Calculate the expected return and variance for these two stocks and interpret the relationship between stock return and variance.

(b) you want to form a portfolio consisting of 100 shares of each of two stocks above and the stock price for stock A and B is $60 per share and $80 per share.

1. what is the expected return of your portfolio?

2. do you expect the overall risk increase or decrease and why?

(c) assume the market return is 5% and risk-free rate is 0.1%

1. Which stock has a higher market risk? why?

2. calculate security market line