Problem 1. Consider the following table, whichgives a security analysts expected return on two stocks for twoparticular market returns:
States | Market Return | Aggressive Stock | Defensive Stock |
Bad Good | 5% 25% | -2% 38% | 6% 12% |
a) What are the betas of the two stocks?
b) What is the expected rate of return on each stock if themarket return is equally likely to be 5% or 25%?
c) If the T-bill rate is 6% and the market return is equallylikely to be 5% or 25%, draw the SML for this economy.
d) Plot the two securities on the SML graph. What are the alphasof each?
Problem 2. Assume that the risk-free rate ofinterest is 6% and the expected rate of return on the market is16%.
a) A share of stock sells for $50 today. It will pay a dividendof $6 per share at the end of the year. Its beta is 1.2. What doinvestors expect the stock to sell for at the end of the year?
b) A stock has an expected rate of return of 4%. What is itsbeta?
