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A share is bought for $12 and the price in one year’s time is forecast using...

A share is bought for $12 and the price in one year’s time is forecast using 3 possible outcomes: $13 with probability 25%, $15 with probability 50%, and an unknown third value, This share has an expected return of 10%. What is the unknown third value?

a. $10.25

b. $9.80

c. $9.00

d. $11.00

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Answer #1

The correct answer is Option B

Current share value = 12

Expected return = 10%

So, Share price after 1 year = Current Price * ( 1 + Expected return)^ Number of year

= 12 * ( 1 + 10%)^1

= 13.2

Share Price at the end of 1 year = P1W1 + P2W2 + ....... + PNWN

P1, P2 .. are the probabilities

W1, W2 ... are the share price

Weightage of Unknown third value = 100% - (25% + 50%)

= 25%

13.2 = 13*25% + 15*50% + 25% * W3

13.2 = 3.25 + 7.50 + 0.25W3

13.2 - 3.25 - 7.50 = 0.25W3

2.45 = 0.25W3

W3 = 2.45/0.25

= $9.8

So, the correct answer is Option B

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