Question

You have been assigned to examine the following funds with their respective probabilities:

		Stock Fund X	Stock Fund Y
Scenario	Probability	Rate of Return (%)	Rate of Return (%)
Severe recession	0.05	-5	11.2
Mild recession	0.15	-1.6	3.3
Normal growth	0.55	7.7	0.5
Boom	0.25	16.3	-4.1

Calculate the expected return of a portfolio that invests 55% on stock fund X and 45% on stock fund Y.

Remember to state your answer as a percentage. For example, 99.99%.

Answer 1

		Stock Fund X	Stock Fund Y
Scenario	Probabillity	Rate of Return ( % )	Expected Rate of return of X[ Probability * Rate of return on X]	Rate of Return ( % )	Expected Rate of return of Y[ Probability * Rate of return on Y]
Severe Recession	0.05	-5	-0.250	11.2	0.560
Mild Recession	0.15	-1.6	-0.240	3.3	0.495
Normal Growth	0.55	7.7	4.235	0.5	0.275
Boom	0.25	16.3	4.075	-4.1	-1.025
	Total		7.820		0.305

Expected Rate of Return on X = Probability * Rate of return on X

Expected Rate of Return on Y = Probability * Rate of return on Y

Computation of Expected return on portfolio

Expected Return on Portfiolio = Weighted portfolio

Expected return on Portfolio = Weight of X ( Expected return on X ) + Weight of Y ( Expected return on Y)

= 0.55( 7.82) +0.45(0.305)

= 4.301+0.13725

= 4.43825

Hence Expected return on the Portfolio is 4.43825%

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