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You know the following information about possible returns offered by two stocks, Umbrella and Resorts, next year. Scenario Probability Return (X) Return (Y) Rainy season

You know the following information about possible returns offered by two stocks, Umbrella and Resorts, next year. Scenario Probability Return (X) Return (Y) Rainy season 0.3 30% -10% Sunny season 0.7 -20% 40%

Scenario: Rainy season

Probability : 0.3

Return (X) : 30%

Return (Y): -10%

Scenario: Sunny season

Probability: 0.7

Return (X): -20%

Return (Y): 40%

Suppose the yield on short-term government securities (perceived to be risk-free) is about 4%. Suppose also that the expected return required by the market for a portfolio with a beta of 1 is 8.0%. Suppose you consider buying a share of stock at a price of $100. The stock is expected to pay a dividend of $2 next year and to sell then for $105. The stock risk has been evaluated at = 1.5. Is the stock underpriced, fairly priced, or overpriced? Should you buy, sell, or hold the stock? Show detailed calculations leading to your answers.

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