Question

Calculate E(r) and the risk premium for each asset using the provided information about the probability of the state of the economy and the indicated returns.

Economy	Profitability	T-Bill	AT&T	Amazon	Market Portfolio
Below Average	18%	2%	4%	24%	7%
Average	60%	2%	12%	16%	12%
Above Average	22%	2%	14%	15%	21%

Answer 1

1. Expected return of T-bill = Probability * Respective return

Expected return of T-bill = 18% *2% + 60% * 2% + 22% * 2%

Expected return of T-bill = 2%

2. Expected return of AT&T = Probability * Respective return

Expected return of AT&T = 18% * 4% + 60% * 12% + 22% * 14%

Expected return of AT&T = 11%

Risk Premium = Expected return of AT&T - Expected return of T-Bill = 11% -2% = 9%

3. Expected return of Amazon = Probability * Respective return

Expected return of Amazon = 18% * 24% + 60% * 16% + 22% * 15%

Expected return of Amazon = 17.22%

Risk Premium = Expected return of Amazon - Expected return of T-Bill = 17.22% -2% = 15.22%

4. Expected return of Market Portfolio = Probability * Respective return

Expected return of Market Portfolio = 18% * 7% + 60% * 12% + 22% * 21%

Expected return of Market Portfolio = 13.08%

Risk Premium = Expected return of Market Portfolio - Expected return of T-Bill = 13.08% -2% = 11.08%