Risk and Return. True or false? Explain or qualify as necessary.

a. The expected rate of return on an investment with a beta of 2 is twice as high as the expected

rate of return of the market portfolio.

b. The contribution of a stock to the risk of a diversified portfolio depends on the market risk

of the stock.

c. If a stock’s expected rate of return plots below the security market line, it is underpriced.

d. A diversified portfolio with a beta of 2 is twice as volatile as the market portfolio.

e. An undiversified portfolio with a beta of 2 is twice as volatile as the market portfolio.

Problem 10-17

Scenario Analysis. Consider the following scenario analysis:

Rate of Return

Scenario Probability Stocks Bonds

Recession 20.0% -5.0% 14.0%

Normal economy 60.0% 15.0% 8.0%

Boom 20.0% 25.0% 4.0%

a. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms?

b. Calculate the expected rate of return and standard deviationfor each investment.

Stocks Bonds

Expected return FORMULA FORMULA

Variance FORMULA FORMULA

Standard Deviation FORMULA FORMULA

c. Which investment would you prefer?

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Risk and Return, Rate of Return and Scenario Analysis are investigated. The solution is detailed and well presented.