Suppose there are only three possible economic outcomes in the next period: boom, normal, and recession. You observe the following information about two stocks:

State Probability

Boom 0.10 Normal 0.60 Recession 0.30

Required:

Return on Stock A

18.0% 8.0% 2.0%

Return on Stock B

(a) Determine the expected return and the standard deviation of return for each stock.

(b) Suppose you are considering an investment in a portfolio consisting of 25% of Stock A and 75% of Stock B. Determine the expected return and the standard deviation of return for the portfolio.

(c) Critically discuss how come Stock B has a higher expected return but a lower standard deviation of return as compared to Stock A in an efficient market. (word limit: 150 words