Question

Consider the following information:

State Probability Stock A Stock B Stock C

Boom 0.32 -0.13 -0.01 -0.05

Bust 0.68 -0.09 0.21 0.02

What is the expected return of a portfolio that has invested $7,440 in Stock A, $14,764 in Stock B, and   $17,508 in Stock C? (Hint: calculate weights of each stock first). Enter the answer with 4 decimals (e.g. 0.1234).

Answer 1

Answer :

Expected Return of A = Sum of (Probability * Weight)

= [(-0.13) * 0.32] + [(-0.09) * 0.68]

= [(-0.0416)] + [(-0.0612)]

= (-0.1028)

Expected Return of B = Sum of (Probability * Weight)

= [(-0.01) * 0.32] + [(0.21) * 0.68]

= [(-0.0032)] + [(0.1428)]

= 0.1396

Expected Return of C = Sum of (Probability * Weight)

= [(-0.05) * 0.32] + [(0.02) * 0.68]

= [(-0.016)] + [(0.0136)]

= (-0.0024)

Weight of Stock = Value invested / Total Value

Expected Return of portfolio = (Expected Return of Stock A * Weight of Stock A) + (Expected Return of Stock B * Weight of Stock B) + (Expected Return of Stock C * Weight of Stock C)

= [(-0.1028)* (7440 / 39712)] + [0.1396 * (14764 / 39712)] + [(-0.0024 * (17508 / 39712)]

= (-0.01925946817) + [0.0519] + (-0.0010580983)

= 0.0316