Question

You have calculated that Stock XYZ has an expected return of 15.64%, which you found using...

You have calculated that Stock XYZ has an expected return of 15.64%, which you found using past historical data as a basis. Also, you feel there is 30% chance of a boom next year, while there is a 25% chance of a recession. Over the past 50 years, Stock XYZ has averaged a return of 16.54% during normal years and 19.29% during booming years. What did it average during recessionary years?

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Answer #1

Expected return is gain or loss an investor anticipates on an investment that has known or expected rates of return. It is calculated by multiplying potential outcomes by the chances of them occurring and then summing these results.

Now, probability of boom = 30%, recession = 25%, normal = 1 - 30% - 25% = 45%

Hence, putting all in equation, let the average during recessionary years be R.

15.64% = (30% * 19.29%) + (25% * R) + (45% * 16.54%)

15.64% = 5.787% + 0.25R + 7.443%

2.41% = 0.25R

R = 9.64% --> Answer

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