Question

Consider the following information: Rate of Return if State Occurs State of Economy Probability of State of Economy Stock A Stock B Stock C Boom .30 .19 .43 .24 Good .20 .17 .17 .14 Poor .10 −.04 −.14 .03 Bust .40 −.16 −.22 −.11 a. Your portfolio is invested 25 percent each in Stocks A and C and 50 percent in Stock B. What is the expected return of the portfolio?

Expected return:____________%

Answer 1

Expected Ret from each Stock = Sum [ Prob * Ret ]

Stock A:

Scenario	Prob	Ret	Prob * Ret
Boom	0.3000	0.1900	0.0570
Good	0.2000	0.1700	0.0340
Poor	0.1000	(0.0400)	(0.0040)
Bust	0.4000	(0.1600)	(0.0640)
Expected Ret			0.0230

Expected Ret of Stock A is 2.30%

Stock B:

Scenario	Prob	Ret	Prob * Ret
Boom	0.3000	0.4300	0.1290
Good	0.2000	0.1700	0.0340
Poor	0.1000	(0.1400)	(0.0140)
Bust	0.4000	(0.2200)	(0.0880)
Expected Ret			0.0610

Expected ret from stock B is 6.10%

Stock C:

Scenario	Prob	Ret	Prob * Ret
Boom	0.3000	0.2400	0.0720
Good	0.2000	0.1400	0.0280
Poor	0.1000	0.0300	0.0030
Bust	0.4000	(0.1100)	(0.0440)
Expected Ret			0.0590

Expected Ret from stock C is 5.90%

Portfolio Ret = weighted Avg Ret of securities in that portfolio.

Stock	Weight	Ret	WTd Ret
Stock A	0.2500	2.30%	0.58%
Stock B	0.5000	6.10%	3.05%
Stock C	0.2500	5.90%	1.48%
Portfolio Ret Return			5.10%

Portfolio Ret from STock A, B and C is 5.10%