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Two stocks: stock D and stock E are trading in the stock market. Stock price of D is $73 now. D will be priced at
Two stocks: stock D and stock E are trading in the stock market. Stock price of D is $73 now. D will be priced at $63 next year if there is a recession, $83 if economy will be normal, and $93 if economy expands again after vaccine of COVID-19 proved to be working globally. The probability of recession, normal and expansionary economy next year are 13%, 73%, and 14% respectively. D pays no cash dividend and has a correlation coefficient of 30% with the market portfolio. Stock E has an expected return of 13%, a standard deviation of 33%, and a correlation coefficient of 9% with the market portfolio and a correlation coefficient of 33% with stock D. The market portfolio has a standard deviation of 13%. Assume the capital asset pricing model holds.
* a. If you are a typical risk averse investor with a well-diversified portfolio, which stock will you prefer? Explain.
* b. What are the expected return and standard deviation of a portfolio having 23% of stock D and 77% of stock E?
* c. What is the beta of the portfolio in part b?
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