Question

Juan owns a two-stock portfolio that invests in Blue Llama Mining Company (BLM) and Hungry Whale Electronics (HWE). Three-quarters of Juan’s portfolio value consists of BLM’s shares, and the balance consists of HWE’s shares.

Each stock’s expected return for the next year will depend on forecasted market conditions. The expected returns from the stocks in different market conditions are detailed in the following table:

Market Condition	Probability of Occurrence	Blue Llama Mining	Hungry Whale Electronics
Strong	0.20	35%	49%
Normal	0.35	21%	28%
Weak	0.45	-28%	-35%

Calculate expected returns for the individual stocks in Juan’s portfolio as well as the expected rate of return of the entire portfolio over the three possible market conditions next year.

1. The expected rate of return on Blue Llama Mining’s stock over the next year is ___?

2. The expected rate of return on Hungry Whale Electronics’s stock over the next year is ___?

3. The expected rate of return on Juan’s portfolio over the next year is ___?

Answer 1

Question 1

> Formula

Expected Return = Sum of [ PX ]

where P means probablity and X means returns

> Calculation

Market Condtion	Probablity	Blue lama	PX
Strong	0.20	35%	7
Normal	0.35	21%	7.35
Weak	0.45	-28%	-12.6
		Answer	1.75%

Question 2

> Formula

Expected Return = Sum of [ PX ]

where P means probablity and X means returns

> Calculation

Market Condtion	Probablity	Hungry Whales	PX
Strong	0.20	49%	9.8
Normal	0.35	28%	9.8
Weak	0.45	-35%	-15.75
		Answer	3.85%

Question 3

Expected Return on portfolio = Weight of Blue Lama * Expected Return Blue Lama + Weight of Hungry Whales * Expected returns Hungry Whales

                                          = 0.75 * 1.75 + 0.25 * 3.85

                                         = 2.275 % Answer

Hope you understand the solution.