Suppose that T-bills currently have a rate of return of 2%. As- sume that borrowing is possible at the risk free rate. You are risk averse and you are considering constructing a portfolio consisting of T-bills and one of the two risky assets: Stock A or Stock B. You did the following scenario analysis on stocks A and B

Events Bull Market Normal Market Bear Market

Probability Stock Ais return 0.3 50% 0.5 18% 0.2 -20%

Stock Bis return 10% 20% -15%

1. (a) Compute the expected rate of return and the standard deviation for Stock A and Stock B.

2. (b) Based on the information you have so far, which of the two risky assets, Stock A or Stock B, would you choose to be included in your portfolio with T-bills? Explain.

3. (c) Your friend is considering the same problem but she is more risk averse than you. Should she arrive at a dierent conclusion than you? Ex- plain.

4. (d) Suppose that you start your portfolio with $1 million and also your portfolio target risk (std dev) is 10% (this is your portfolio from part (b)), how many dollars will you invest in T-bills? What is your port- foliois expected return? Show your work.