Question

1. (7 pts) We have a total of $10,000 to invest and decide to invest $7,000 in Stock A and $3,000 in Stock B.  Assume the following expectations about Stock A and Stock B.  

State of the Econ.          Probability        Exp.Ret (Stock A)           Exp. Ret (Stock B)      

Recession                        10%                           -4%                              2%
Normal                            60%                           10%                              4%
Expansion                        30%                           16%                              6%        

Calculate the Return of the portfolio containing $7,000 in Stock A and $3,000 in Stock B under each of the given states of the economy

State of the Econ.          Probability        Return of the Portfolio containing $7000 in A and $3000 in B       

Recession                        10%               _____%

                                    
Normal                           60% ______%

                                                                        
Expansion                       30% _________%

What is the overall Expected return of the $10,000 portfolio?

Expected Return on the Portfolio =

Answer 1

Answer:-

Weight of Stock A = Amount Invested in Stock A / Amount Invested in Portfolio
Weight of Stock A = $7,000 / $10,000
Weight of Stock A = 0.70

Weight of Stock B = Amount Invested in Stock B / Amount Invested in Portfolio
Weight of Stock B = $3,000 / $10,000
Weight of Stock B = 0.30

Recession:

Return of Portfolio = 0.70 * (-0.04) + 0.30 * 0.02

Return of Portfolio = -0.028 + 0.006
Return of Portfolio = -0.022 or -2.20%

Normal:

Return of Portfolio = 0.70 * 0.10 + 0.30 * 0.04

Return of Portfolio = 0.07 + 0.012,
Return of Portfolio = 0.082 or 8.20%

Expansion:

Return of Portfolio = 0.70 * 0.16 + 0.30 * 0.06

Return of Portfolio = 0.112 + 0.018
Return of Portfolio = 0.13 or 13.00%

Overall Return of Portfolio = 0.10 * (-0.022) + 0.60 * 0.082 + 0.30 * 0.130

Overall Return of Portfolio = -0.0022+0.0492+0.039

Overall Return of Portfolio = 0.086 or 8.60%