Question

Answer the following question based on the information below: State of Economy Probability Stock A’s return Stock B’s return Boom .4 15% - 30% Recession .6 5% 40% If you invest $50,000 in each of stocks A and B, what is the expected return for your portfolio? p

Answer 1

Let

Returns from Stock A be X and Stock B be Y.

Probability be P

• The Expected Return of Stock A is total of PX column
• The Expected Return of Stock B is total of PY column

Expected Return of the Portfolio = Weight of Stock A * Expected Return of Stock A + Weight of Stock B * Expected Return of Stock B

Calculation of Weights

Weight of Stock A = Investment in Stock A / Total Investment

Weight of Stock B = Investment in Stock B / Total Investment

Investment in Stock A = $50,000

Investment in Stock B = $50,000

Total Investment = $100,000

Weight of Stock A = $50,000 / $100,000

= 0.50 or 50%

Weight of Stock B = $50,000 / $100,000

= 0.50 or 50%

Expected Return of the Portfolio = 0.50 * 9 + 0.50 * 12

= 4.5 + 6

= 10.50 %