Question

You recently purchased a stock that is expected to earn 12% in a booming economy, 8% in a normal economy and lose 5% in a recessionary economy. There is a 15% probability of a boom, a 75% chance of a normal economy, and a 10% chance of a recession. What is your expected rate of return on this stock

Answer 1

Answer:

The expected return on this stock is 7.3%

Explanation:

Using the expectations model, we can calculate the expected return on the stock based on the return on stock in different scenarios/states and the probability of those states.

The expected return on the stock is,

Expected r = rA * pA  +  rB * pB  + rC * pC

Where,

• r represents the returns in each state
• p represents the probability of each state

Expected r = 0.12  * 0.15  +  0.08 * 0.75  +  (-0.05 * 0.1)

Expected r = 0.073 or 7.3%