Question

The following table provides stock return distributions in the coming year for three companies, A, B,...

The following table provides stock return distributions in the coming year for three companies, A, B, and C.

State of Economy Probability of State of Economy

Stock A

Rate of Return

Stock B

Rate of Return

Stock C

Rate of Return

Normal 0.65 14.3% 16.7% 18.2%
Recession 0.35 -9.8% 5.4% -26.9%

(a) Consider a portfolio that is invested 40 percent in Stock A, 30 percent in Stock B, and the remainder in Stock C. What is the expected return on the portfolio?

(b) What is the standard deviation on the portfolio returns above?

Homework Answers

Answer #1

a) Expected return of Portfolio in Normal=40%*Return of Stock A+30%*Return of Stock B+30%*Return of Stock C
=40%*14.3%+30%*16.7%+30%*18.2% =16.19%
Expected return of Portfolio in Recession=40%*Return of Stock A+30%*Return of Stock B+30%*Return of Stock C
=40%*-9.8%+30%*5.4%+30%*-26.9% =-10.37%

Expected Return on Portfolio =0.65*16.19%+0.4*-10.37% =6.3755% or 6.38%

b) Standard Deviation of Portfolio Returns =(0.65*(16.19%-6.3755%)^2+0.35*(-10.37%-6.3755%)^2)^0.5 =12.68%



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