Question

The rate of return on the common stock of Lancaster Woolens is expected to be 21 percent in a boom economy, 11 percent in a normal economy, and only 3 percent in a recessionary economy. The probabilities of these economic states are 10 percent for a boom, 70 percent for a normal economy, and 20 percent for a recession. What is the variance of the returns on this common stock?

Answer 1

Answer:

0.002244

Explanation:

We will first calculate the expected return. It is:  E(r)

E(r) = (0.10 0.21) + (0.70 0.11) + (0.20 0.03)

                  = 0.104

Var = 0.10 (0.21 - 0.104)2 + 0.70 (0.11 - 0.104)2 + 0.20 (0.03 - 0.104)2

= 0.002244