Question

You decide to invest in a portfolio consisting of 30 percent Stock A, 30 percent Stock B, and the remainder in Stock C. Based on the following information, what is the expected return of your portfolio?

State of Economy	Probability of State			Return if State Occurs
	of Economy			Stock A			Stock B			Stock C
Recession		.17		-	18.8	%	-	3.9	%	-	22.8	%
Normal		.45			10.2	%		8.5	%		17.1	%
Boom		.38			28.6	%		15.8	%		31.7	%

13.94%

12.77%

13.36%

15.10%

16.47%

Answer 1

Step-1:Calculation of expected return of each stock
	Stock A:
	State of economy	Probability of state of economy	Return if state occurs	expected return with probability
		a	b	c=a*b
	Recession	0.17	-18.80%	-3.20%
	Normal	0.45	10.20%	4.59%
	Boom	0.38	28.60%	10.87%
	Total			12.26%
	Stock B:
	State of economy	Probability of state of economy	Return if state occurs	expected return with probability
		a	b	c=a*b
	Recession	0.17	-3.90%	-0.66%
	Normal	0.45	8.50%	3.83%
	Boom	0.38	15.80%	6.00%
	Total			9.17%
	Stock C:
	State of economy	Probability of state of economy	Return if state occurs	expected return with probability
		a	b	c=a*b
	Recession	0.17	-22.80%	-3.88%
	Normal	0.45	17.10%	7.70%
	Boom	0.38	31.70%	12.05%
	Total			15.87%
Step-2:Calculation of expected return of portfolio
		Weight	Return
		a	b	c=a*b
	Stock A	0.30	12.26%	3.68%
	Stock B	0.30	9.17%	2.75%
	Stock C	0.40	15.87%	6.35%
	Total			12.77%
	So, expected return of portfolio is			12.77%