Question

Consider the following information: State Probability Stock A Stock B Stock C Boom 0.65 0.01 0.16...

Consider the following information:

State Probability Stock A Stock B Stock C

Boom 0.65 0.01 0.16 0.22

Bust 0.35 0.20 -0.06 0.10

What is the expected return on an equally weighted portfolio of these three stocks? (Hint: Equally means that each stock has the same weight. Given that there are only 3 stocks, each has a weight of 1/3) Enter the answer with 4 decimals (e.g. 0.1234).

Homework Answers

Answer #1

weighted return when the state of the economy is boom:

stock return weight weight * return
A 0.01 1/3 0.00333333
B 0.16 1/3 0.05333333
C 0.22 1/3 0.07333333
Total weigheted return under boom 0.1299999

weighted return when economy is bust:

stock return weight weight*return
A 0.20 1/3 0.0666666
B -0.06 1/3 -0.02
C 0.10 1/3 0.033333
total weighted return under bust 0.0799999

expected return on portfolio

=>[(probability of boom) * (weighted average return on boom)] + [(probability of bust)*(weighted average return on bust)]

=>[0.65 * 0.1299999] + [0.35*0.0799999]

=>0.11249999998

=>0.1125.....(rounded to four decimals)

expected return on an equally weighted portfolio of these three stocks =>0.1125.

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