Question

You have a portfolio which is comprised of 70 percent of stock A and 30 percent of stock B. What is the expected return on this portfolio?

State of Economy	Probability	E(R) A	E(R) B
Weight	0	60%	40%
Boom	0.2	20%	15%
Normal	0.6	12%	8%
Recession	0.2	-10%	3%

		7.30 percent
		7.58 percent
		8.03 percent
		8.96 percent
		9.40 percent

Answer 1

Expected return of Stock-A

Expected return of Stock-A = (60.00% x 0.00) + (20.00% x 0.20) + (12.00% x 0.60) + (-10.00% x 0.20)

= 0.00% + 4.00% + 7.20% - 2.00%

= 9.20%

Expected return of Stock-B

Expected return of Stock-B = (40.00% x 0.00) + (15.00% x 0.20) + (8.00% x 0.60) + (3.00% x 0.20)

= 0.00% + 3.00% + 4.80% + 0.60%

= 8.40%

Expected return on the portfolio

Expected return on the portfolio = (Expected return of Stock-A x Weight of Stock-A) + (Expected return of Stock-B x Weight of Stock-B)

= (9.20% x 0.70) + (8.40% x 0.30)

= 6.44% + 2.52%

= 8.96%

Therefore, the Expected return on the portfolio will be 8.96 percent