Question

Given the following information about the returns of stocks A, B, and C, what is the expected return of a portfolio invested 30% in stock A, 40% in stock B, and 30% in stock C?

State of Economy	Probability	Stock A	Stock B	Stock C
Boom	0.19	0.36	0.24	0.37
Good	0.22	0.21	0.12	0.24
Poor	0.28	0.06	0	0.02
Bust	--	-0.1	-0.27	-0.25

Answer must be in percents!

Answer 1

Probability of Bust = 100% -(19%+22%+28%)

= 31%

Expected Return on the Portfolio = Weight of Respective Stocks * Expected returns of Respective Stocks

=30%*10.04%+40%*(-1.17%)+30%*5.12%

= 4.08%

Answer = 4.08%

Notes:

Sock A expected return =

State of Economy	Probability	Expected Stock Return on Stock	Expected Return ( Probability * Expected Stock Return)
Boom	0.19	0.36	0.0684
Good	0.22	0.21	0.0462
Poor	0.28	0.06	0.0168
Bust	0.31	-0.10	-0.0310
	Expected Return	0.1004
	Expected Return   %	10.04 %

Stock B Expected Return :

State of Economy	Probability	Expected Stock Return on Stock	Expected Return ( Probability * Expected Stock Return)
Boom	0.19	0.24	0.0456
Good	0.22	0.12	0.0264
Poor	0.28	-	-
Bust	0.31	-0.27	-0.0837
	Expected Return	-0.0117
	Expected Return   %	-1.17 %

Stock C Expected return :

State of Economy	Probability	Expected Stock Return on Stock	Expected Return ( Probability * Expected Stock Return)
Boom	0.19	0.37	0.0703
Good	0.22	0.24	0.0528
Poor	0.28	0.02	0.01
Bust	0.31	-0.25	-0.0775
	Expected Return	0.0512
	Expected Return   %	5.12