Question

Consider returns R on a stock XYZ in the follwoing 4 states of he economy. each with probability p Boom state: p=0.15, R=35% Normal state: p=???, R=8% Slowdown state: p=0.1, R=1% Recession state: p=0.2, R = -33% What is the expected return for stock XYZ? Quote your answer to 1 decimal place, but do not type the "%" Do not round intermediate results.  

Answer 1

The expected return is computed as shown below:

= Probability of boom state x expected return in boom state + Probability of Normal state x expected return in normal state + Probability of Slowdown state x expected return in slowdown state + Probability of recession state x expected return in recession state

Probability of normal state is computed as follows:

= 1 - ( Probability of boom state + Probability of Slowdown state + Probability of Recession state)

= 1 - ( 0.15 + 0.10 + 0.20)

= 0.55

So, the expected return is computed as follows:

= 0.15 x 0.35 + 0.55 x 0.08 + 0.10 x 0.01 + 0.20 x - 0.33

= 0.0525 + 0.044 + 0.001 - 0.066

= 3.2 Approximately

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