Question

You recently purchased a stock that is expected to earn 17 percent in a booming economy, 12 percent in a normal economy, and lose 5 percent in a recessionary economy. There is 17 percent probability of a boom, 66 percent chance of a normal economy, and 17 percent chance of a recession. What is your expected rate of return on this stock?

8.00%

4.17%

9.96%

4.98%

9.67%

Answer 1

Answer is 9.96%

Probability of Boom = 17%
Expected Return in Boom = 17%
Probability of Normal = 66%
Expected Return in Normal = 12%
Probability of Recession = 17%
Expected Return in Recession = -5%

Expected Rate of Return = Probability of Boom * Expected Return in Boom + Probability of Normal *
Expected Return in Normal + Probability of Recession * Expected Return in Recession
Expected Rate of Return = 17% * 17% + 66% * 12% + 17% * (-5%)
Expected Rate of Return = 9.96%