There are 4 short answer questions for a total of 100 points. Please provide your answers on the black space and use the back of the page for more space. Also, please sign your name under the honor code at the last page. You have 120 minutes to complete the exam. Good luck! 1. (25 points total) The returns (in %) to two mutual funds, Pro-Cyclical (P) and Counter-Cyclical (C), under recession and no-recession scenarios, are reported in the following table: Mutual funds Pro-Cyclical (P) Counter-Cyclical (C) Recession -20 10 No recession 15 5 Suppose at any given point of time, the probability of a recession occurring is 10%, so the probability of a recession not occurring is 90%. a. (9 points) Calculate the expected returns to two stocks. b. (8 points) Suppose that based on your calculations in (a), an investor concludes that he would only hold the stock with the higher return. How would you persuade him that asset diversification would reduce his risk? c. (8 points) Apply CAPM to explain (1) the implications of Beta of a mutual fund, and (2) which asset would have a higher Beta. No calculations are necessary but please use 1-2 sentences to explain your answers.