Problem: (Section Four) Expected Returns. Consider the following two scenarios for the economy, and the returns in each scenario for the market portfolio, an aggressive stock A, and a defensive stock D.
Rate of Return
Scenario Market Aggressive Stock A Defensive Stock D
Bust -8% -10% -6%
Boom 32 38 24
Q1. Find the beta of each stock. In what way is stock D defensive?
Q2. If each scenario is equally likely, find the expected rate of return on the market portfolio and on each stock.
Q3. If the T-bill rate is 4 percent, what does the CAPM say about the fair expected rate of return on the two stocks?
Q4. Which stock seems to be a better buy based on your answers to (1) through (3)?