You recently purchased a stock that is expected to earn 11 percent in a booming economy, 9 percent in a normal economy and lose 6 percent in a recessionary economy. There is a 15 percent probability of a boom, a 74 percent chance of a normal economy. What is your expected rate of return on this stock

Question

Business

Maddox Barron

14 January, 04:16

You recently purchased a stock that is expected to earn 11 percent in a booming economy, 9 percent in a normal economy and lose 6 percent in a recessionary economy. There is a 15 percent probability of a boom, a 74 percent chance of a normal economy. What is your expected rate of return on this stock

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Answers (1)

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Cherish Schroeder · Answer 1

Expected rate of return = 7.7%

Explanation:

The expected return on the stock would be the sum of the the probability of outcome times the outcome return. It is given using the relationship below

E = ∈ Ri. Pi

Expected return = (11% * 0.15) + (9% * 0.74) + (-6%) * 0.11) = 7.7%

Note that the probability of recession = 1 - (0.74+0.15) = 0.11. This is so because the sum of the probability should equal 1

Expected rate of return = 7.7%