Consider the following five assets, which have rates of return in six equally likely possible scenarios:

Scenarios Awful Poor Med. Okay Good Great Asset P1 –2% 0% 2% 4% 6% 10%

Asset P2 –1% 2% 2% 2% 3% 3%

Asset P3 –6% 2% 2% 3% 3% 1%

Asset P4 –4% 2% 2% 2% 2% 20%

Asset P5 10% 6% 4% 2% 0% –2%

(a) Assume you can only purchase one of these assets.What are their risks and rewards?

(b) Supplement your previous risk-reward rankings of assets P1–P5 with those of combination portfolios that consist of half P1 and half of each of the other 4 portfolios, P2–P5. What are the risks and rewards of these four portfolios?

(c) Assume that P1 is the market. Plot the rates of return for P1 on the x-axis and the return for each of the other stocks on their own y-axes. Then draw lines that you think best fit the points. Do not try to compute the beta—just use the force

(and your eyes), Luke. If you had to buy just a little bit of one of these P2–P5 assets, and you wanted to lower your risk, which would be best?