Question

The common stock of Steve & Rob is expected to earn 38 percent in a boom economy, 9 percent in a normal economy, and lose 20 percent in a recession. The probability of a recession is 25 percent while the probability of a boom economy is 45 percent. What is the expected rate of return on this stock? Hint: First find the probability of normal economy. Only Enter the Final Answer in Decimals.

Select one of the following:

0.136

0.054

1.01

0.148

0.105

0.075

Answer 1

Answer is 0.1480

Probability of Recession = 0.25
Probability of Boom = 0.45

Probability of Normal + Probability of Recession + Probability of Boom = 1.00
Probability of Normal + 0.25 + 0.45 = 1.00
Probability of Normal = 0.30

Return during Recession = -0.20
Return during Normal = 0.09
Return during Boom = 0.38

Expected Rate of Return = Probability of Recession * Return during Recession + Probability of Normal * Return during Normal + Probability of Boom * Return during Boom
Expected Rate of Return = 0.25 * (-0.20) + 0.30 * 0.09 + 0.45 * 0.38
Expected Rate of Return = 0.1480