Question

What is the expected return on this stock given the following information?

Answer 1

Answer:

The expected return on this stock is:

C. -6.80%.

Explanation:

a) Data and Calculations:

State of the  Economy      Probability     E(R)    Weighted Value

Boom                                  0.40             16%      0.064

Recession                          0.60            -22%    -0.132

Total expected returns                                      -0.068

= -6.8%

Let us assume that this stock is Stock A.  Therefore, Stock A's expected return is given by adding the weighted returns of the two economic states of Boom and Recession.  The result shows that the returns will be negative (-6.8%).  This implies that instead of appreciating in value, the stock will actually depreciate by 6.8%.