Return and Risk:

Consider the following scenario:

Rate of Return

Scenario Prob. Stocks Bonds

Recession .20 -5% 14%

Normal .60 15% 8%

Boom .20 25% 4%___

1. What is the expected return for each investment?

Bonds:

Stocks:

Portfolio (40% in bonds, 60% in stocks):

2. What is the risk for each investment?

Bonds:

Stocks:

Portfolio (40% in bonds, 60% in stocks):

3. Which investment do you prefer?

A. Bonds B. Stocks C. Portfolio

4. Investors expect the market return this year to be 14%. A stock with a beta of .8 has an expected return of 12%. If the market return this year turns out to be 10%, what is your best guess as to the rate of return on the stock?

Suppose that the S&P500 has an expected return of 15% and T-bills provide a risk-free rate of 5%.

5. How to construct a portfolio from these two assets with an expected return of 12%?

Weight for S&P500:

Weight for T-bills:

6. How to construct a portfolio from these two assets with a beta of .4?

Weight for S&P500:

Weight for T-bills: