There are two stock markets, each driven by the same common force, F, with an expected value of zero and standard deviation of 8 percent. There are many securities in each market; thus, you can invest in as many stocks as you wish. Due to restrictions, however, you can invest in only one of the two markets. The expected return on every security in both markets is 8 percent.

The returns for each security, i, in the first market are generated by the relationship:

R_1i = .08 + 1.5F + _1i

where _1i is the term that measures the surprises in the returns of Stock i in Market 1. These surprises are normally distributed; their mean is zero. The returns on Security j in the second market are generated by the relationship:

R_2j = .08 + .5F + _2j

where _2j is the term that measures the surprises in the returns of Stock j in Market 2. These surprises are normally distributed; their mean is zero. The standard deviation of _1i and _2i for any two stocks, i and j , is 20 percent.

Assume the correlation between the surprises in the returns of any two stocks in the first market is zero, and the correlation between the surprises in the returns of any two stocks in the second market is zero.

a.	What are the variances for the first and second market? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.)

	Variance
Market 1 __________
Market 2 __________

a-1.

In which market would a risk averse person prefer to invest?

	Market 1 ___
	Market 2 ___

Assume the correlation between _1i and _1j in the first market is .5 and the correlation between _2i and _2j in the second market is zero.

b.	What are the variances for the first and second market? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.)

	Variance
Market 1 __________
Market 2 __________

b-1.

In which market would a risk averse person prefer to invest?

	Market 1 ___
	Market 2 ___

c.

Assuming the correlation between _1i and _1j in the first market is zero and the correlation between _2iand _2j in the second market is .32, in which market would a risk-averse person prefer to invest?

	Market A ___
	Market B ___
	Indifferent between two markets ___