(a) Donald is considering the merits of two securities. He is interested in the common shares of A Co. and B Inc. The expected monthly rate of return of securities is shown below: State of Affair...

(a) Donald is considering the merits of two securities. He is interested in the common shares of
A Co. and B Inc. The expected monthly rate of return of securities is shown below:
State of Affair Probability Stock A Stock B
Boom 0.1 40% -20%
Normal 0.5 20% 8%
Recession 0.4 -10% 15%
At the time of purchase, the market value is $70/share for A and $50/share for B. Donald
plans to invest 10,000 shares of Stock A and 6,000 shares in Stock B.
(i) Compute the portfolio weights of Stock A and Stock B.
(ii) Compute the expected returns of Stock A and Stock B.
(iii) Assume that the covariance between Stock A and Stock B is -28%2
(0.0028). Compute
the expected rate of return and variance of rate of return of Donald’s portfolio.


(iv) If the risk-free rate is 2%, the market risk premium is 18% and the beta of Stock A is
0.75, estimate the required and expected rates of return of Stock A. Should Donald
invest in Stock A? Show the calculations.