You are considering purchasing a stock. In a growing economy, the potential return is 20 percent,...

You are considering purchasing a stock. In a growing economy, the potential return is 20 percent, but if the economy stagnates, the potential return is only 7 percent. In the case of a recession, you could sustain a loss since the anticipated return is -8 percent. The probability of economic growth is 60 percent, while the probability of stagnation and recession are 30 percent and 10 percent respectively. Assume the risk-free rate and the Security’s risk premium were 7 percent and 8 percent, respectively. Required: i. What is your return expectation on this investment? ii. What is the total expected volatility in the investment returns? iii. Calculate the minimum rate of return you would require from the investment.iv explain whether you should proceed and buy the stock

Solutions

Expert Solution

(i ): Expected return= 13.30%

(ii): Total expected volatility of returns (Standard Deviation)= 9.1766%

(iii): Total required return= Risk free rate + risk premium = 7%+ 8% = 15%

(iv): Since the expected return of 13.3% is less than the required return, the stock shall not be bought.

Calculation of expected return and standard deviation as follows:

jeff jeffy answered 1 year ago

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