1. The following two stocks are available for purchase. Utilize this information to answer questions A thru C.

E(R)

Stock A Stock B

State p(i) E(Ra) E(Rb)

Recession 20% -30% -20%

Normal 50% 10% 10%

Expansion 30% 30% 20%

Beta 1.8 1.2

R_f 3%

R_M 5%

1. What return would you expect on each stock based on the Capital Asset Pricing Model?
2. Are the two stocks under or over-valued based on the Capital asset Pricing Model?
3. What mix of the two stocks would you choose?