Question

You have estimated the following probability distributions of expected future returns for stocks A and B

                        Stock A                                                            Stock B

Probability                  Return                                     Probability                  Return

                                                                                                                                   

0.1                                       -10%                                                   0.2                                       2%

0.2                                       10%                                                    0.2                                       7%

0.4                                       15%                                                    0.3                                       12%

0.2                                       20%                                                    0.2                                       15%

0.1                                       40%                                                    0.1                                       165

                                                                                                                                                                    

a. What is the expected return of stock A?            (25 points)

b. What is the expected return of stock B?            (25 points)

Answer 1

Solution:-

Formula for expected return of the stock = Summation of (Returns*Probability)

a) For Stock A:-

Expected return of "A"= 0.10*(-10)+0.20*10+0.4*15+0.2*20+0.1*40       = 15%

b)For stock "B":-

Expected return of "B"= 0.2*2+0.2*7+0.3*12+0.2*15+0.1*165

                                          = 24.90%

Note:- The last return for the stock B is not clear so i have assumed 165% . If there is any typing mistake Please replace the value of 165% with the correct one then that will be the answer.

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