Question

Scenario Analysis and Portfolio Risk. The common stock of Leaning Tower of Pita Inc., a restaurant chain, will generate payoffs to investors next year, which depend on the state of the economy, as follows: ( LO11-2 and 2011-3) 

 90 Normal economy 

	Dividend	Stock Price
Boom	$8	$240
Normal economy	4	90
Recession	0	0

a. The company goes out of business if a recession hits. Calculate the expected rate of return and standard deviation of return to Leaning Tower of Pita shareholders. Assume for simplicity that the three possible states of the economy are equally likely. The stock is selling today for $80.

Answer 1

a

Return in boom

rate of return/HPR = ((Ending price+Dividend)/Beginning price-1)

=((240+8)/80-1)

=210%

Return in normal economy

rate of return/HPR = ((Ending price+Dividend)/Beginning price-1)

=((90+4)/80-1)

=17.5%

Stock
Scenario	Probability	Return%	=rate of return% * probability	Actual return -expected return(A)%	(A)^2* probability
Recession	0.3333	0	0	-75.82575	0.191632314
Normal	0.3333	17.5	5.83275	-58.32575	0.113385097
Boom	0.3333	210	69.993	134.17425	0.60003097
	0	0	0	-75.82575	0
	Expected return %=	sum of weighted return =	75.83	Sum=Variance Stock=	0.90505
			Standard deviation of Stock%	=(Variance)^(1/2)	95.13

Return in recession

rate of return/HPR = ((Ending price+Dividend)/Beginning price-1)

=((0+0)/80-1)

=-100%