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You are given the following information about Stock 1 and Stock 2. Rate of return if State Occurs State of economy Probability of State of

You are given the following information about Stock 1 and Stock 2.

Rate of return if State Occurs
State of economy Probability of State of Economy Stock 1 Stock 2
Recession 0.25 0.11 -0.4
Normal 0.5 0.29 0.1
Boom 0.25 0.13 0.56

The market risk premium is 8% and the risk-free rate is 4%.

(a) Use an appropriate computing tool to help you work out the following.

(i) Calculate the expected returns of Stock 1 and Stock 2.

(ii) Appraise which stock has the higher systematic risk.

(iii) Compute the total risk of each stock.

(iv) Appraise which stock is riskier.

(b) Discuss whether a risky asset can have a negative beta and what the CAPM predicts about its return.

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