Question

# The rate of return on the common stock of Lancaster Woolens is expected to be 18...

The rate of return on the common stock of Lancaster Woolens is expected to be 18 percent in a boom economy, 8 percent in a normal economy, and only 2 percent in a recessionary economy. The probabilities of these economic states are 12 percent for a boom and 10 percent for a recession. What is the expected risk on this common stock? [3 points] a. 0.01150 b. 0.01306 c. 0.12345 d. 0.001389 e. 0.001421

Return during Boom = 18%
Return during Normal = 8%
Return during Recession = 2%

Probability of Boom = 12%
Probability of Normal = 78%
Probability of Recession = 10%

Expected Return = 0.12 * 0.18 + 0.78 * 0.08 + 0.10 * 0.02
Expected Return = 0.0860 or 8.60%

Variance = 0.12 * (0.18 - 0.086)^2 + 0.78 * (0.08 - 0.086)^2 + 0.10 * (0.02 - 0.086)^2
Variance = 0.001524

Standard Deviation = (0.001524)^(1/2)
Standard Deviation = 0.0390 or 3.90%

Therefore, expected risk on this common stock is 0.001524

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