Question

Southern Wear stock has an expected return of 15.1 percent. The stock is expected to lose 8 percent in a recession and earn 18 percent in a boom. The probabilities of a recession, a normal economy, and a boom are 2 percent, 87 percent, and 11 percent, respectively. What is the expected return on this stock if the economy is normal?14.79 percent17.04 percent15.26 percent16.43 percent11.08 percent

Answer 1

Answer:

15.26%

Explanation:

Given:

Expected return = 15.1% = 0.151

Expected loss in recession = - 8% = - 0.08   [negative sign depicts loss]

Expected earning in a boom = 18% = 0.18

Probabilities of a recession = 2% = 0.02

Probabilities of a normal economy = 87% = 0.87

Probabilities of a boom = 11% = 0.11

Now,

Expected return = ∑ (Probability × Return)

or

0.151 = 0.02 × ( - 0.08) + 0.11 × 0.18 + 0.87 × Return on normal economy

or

0.151 = - 0.0016 + 0.0198 + 0.87 × Return on normal economy

or

0.151 - 0.0182  = 0.87 × Return on normal economy

or

Return on normal economy = 0.1526

or

= 0.1526 × 100%

= 15.26%