Question

You decide to invest in a portfolio consisting of 40 percent Stock A, 40 percent Stock B, and the remainder in Stock C. Based on the following information, what is the expected return of your portfolio? State of Economy Probability of State Return if State Occurs of Economy Stock A Stock B Stock C Recession .18 - 18.6 % - 3.8 % - 22.7 % Normal .55 10.4 % 8.4 % 17.0 % Boom .27 28.4 % 15.7 % 31.6 .

Answer 1

Expected return on Stock A = 10.04%

Expected return on Stock B = 8.18%

Expected return on Stock C = 13.80%

Expected Return on Portfolio = Expected return on Stock A * Weight of Stock A +Expected return on Stock B * Weight of Stock B +Expected return on Stock C * Weight of Stock C

= 10.04 % * 40% + 8.18% *40% + 13.80 % * 20%

= 10.05%

Hence the correct answer is 10.05%

Notes:

	Probability	Expected Stock Return on Stock A	Expected Return ( Probability * Expected Stock Return)
Recession	0.18	-0.1860	-0.0335
Normal	0.55	0.1040	0.0572
Boom	0.27	0.2840	0.0767
	Expected Return		0.1004
	Expected Return   %		10.04

	Probability	Expected Stock Return on Stock B	Expected Return ( Probability * Expected Stock Return)
Recession	0.18	-0.0380	-0.0068
Normal	0.55	0.0840	0.0462
Boom	0.27	0.1570	0.0424
	Expected Return		0.0818
	Expected Return   %		8.18

	Probability	Expected Stock Return on Stock C	Expected Return ( Probability * Expected Stock Return)
Recession	0.18	-0.2270	-0.0409
Normal	0.55	0.1700	0.0935
Boom	0.27	0.3160	0.0853
	Expected Return		0.1380
	Expected Return   %		13.80