Question

The Inferior Goods Co. stock is expected to earn 13% in a recession, 7% in a normal economy, and lose 6% in a booming economy. The probability of a boom is 20% while the probability of a normal economy is 55% and the chance of a recession is 25%. What is the expected rate of return on this stock?

Answer 1

Answer:

Ans. The expected rate of return on the Inferior Goods Co. stock is 5.90%

Explanation:

Hi, you just have to multiply the expected earnings by the probability of occurance of a certain event and then add up all the products. Here is the information all organized to be processed.

Item                  Prob Earn

Booming           20% -6%

Normal           55% 7%

Recession   25% 13%

Ok, now let´s calculate the expected rate of return.

$ExpectedReturn=(0.2*(-0.06))+(0.55*0.07)+(0.25*0.13)$

$ExpectedReturn=-0.012+0.039+0.033=0.059$

So the expected rate of return of the stock is 5.90%

Best of luck.