a.
Adequate information:
Probability in bust (PBU) = 0.15
Probability in normal (PNO) = 0.60
Probability in boom (PB0) = 0.25
Expected return for stock A in Bust (R (A) BU) = -0.13
Expected return for stock A in Normal (R (A) NO) = 0.12
Expected return for stock A in Boom (R (A) BO) = 0.34
Expected return for stock B in Bust (R (B) BU) = -0.11
Expected return for stock B in Normal (R (B) NO) = 0.10
Expected return for stock B in Boom (R (B) BO) = 0.31
To compute: Expected return on each stock
Introduction: Expected return on stock refers to the return a stock likely to generate at a future date.
b.
Adequate information:
Probability in bust (PBU) = 0.15
Probability in normal (PNO) = 0.60
Probability in boom (PB0) = 0.25
Expected return for stock A in Bust (R (A) BU) = -0.13
Expected return for stock A in Normal (R (A) NO) = 0.12
Expected return for stock A in Boom (R (A) BO) = 0.34
Expected return for stock B in Bust (R (B) BU) = -0.11
Expected return for stock B in Normal (R (B) NO) = 0.10
Expected return for stock B in Boom (R (B) BO) = 0.31
To compute: The expected market risk premium when Stock A’s beta is greater than Stock B’s beta by 0.25.
Introduction: The difference between the risk-free rate and the expected return on a market portfolio is referred to as market risk premium.
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