The market risk premium is 7.4 percent, and the risk-free rate is 3.1 percent. The beta of Stock A is and the beta of Stock B is .

1.25; 1.41

Explanation:

Consider the following information: State of Economy Probability of State of Economy Rate of Return if State Occurs Stock A Stock B Recession .04 .097 .102 Normal .72 .114 .133 Boom .24 .156 .148 The market risk premium is 7.4 percent, and the risk-free rate is 3.1 percent. The beta of Stock A is and the beta of Stock B is .

12.3

Beta = (rate of return - risk free rate) / market premium

rate of return = (r1 x p1) + (r2 x p2) + (r3 x p3)

p1 = probability of recession

p2 = return in recession

Stock A = (0.04 X 0.097) + (0.72 X 0.114) + (0.24 X 0.156) = 12.3

Beta for stock A = 0.123 - 0.031) / 0.074 = 1.25

Stock B =  (0.04 X 0.102) + (0.72 X 0.133) + (0.24 X 0.148) = 13.5

Beta for stock B = (0.135 -  0.031) / 0.074 = 1.41

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