Question

Assume the economy has an 6 percent chance of booming, am 8 percent chance of being recessionary, and being normal the remainder of the time. A stock is expected to return 22.5 percent in a boom, 11.5 percent in a normal economy, and −8 percent in a recession. What is the expected rate of return on this stock?

Answer 1

Answer:

Expected return = 10.6%

Explanation:

Expected return = SUM(prob. *return)

Prob.(normal) = 100% - 6% - 8% = 86%

Plug in the numbers in the above formula. (I'll be using them as decimals)

Expected return = (0.06*0.225) + (0.08 * -0.08) + (0.86 * 0.115)

= 0.0135 -0.0064 + 0.0989

= 0.106 or 10.6% as a percentage

Therefore, the expected return = 10.6%