Question

1. Based on the following information, calculate the expected return and standard deviation for Stock A and Stock B:

State Of Economy	Prob of State	Stock A	Stock B
Recession	0.20	0.07	-0.05
Normal	0.45	0.09	0.12
Boom	0.35	0.17	0.27

Answer 1

Expected return = sum of [probability*return]

Expected return for Stock A = (0.20*0.07)+(0.45*0.09)+(0.35*0.17) = 11.40%

Expected return for Sock B = (0.20*-0.05)+(0.45*0.12)+(0.35*0.27) = 13.85%

Standard deviation = [sum of (probability*(return - expected return)^2)]^0.5  

Standard deviation for Stock A = [0.20*(0.07-0.114)^2 + 0.45*(0.09-0.114)^2 + 0.35*(0.17-0.114)^2]^0.5 = 0.04176 or 4.176%

Standard deviation for Stock B = [0.20*(-0.05-0.1385)^2 + 0.45*(0.12-0.1385)^2 + 0.35*(0.27-0.1385)^2]^0.5 = 0.11538 or 11.538%