Consider the following information Rate of Return if State Occurs State of Econo

Question

Consider the following information Rate of Return if State Occurs State of Economy Boom Bust Probability of State of Economy 0.56 0.44 Stock A 0.06 0.11 Stock B 0.14 0.02 Stock C 0.34 -0.07 a. What is the expected return on an equally weighted portfolio of these three stocks? (Do not round intermediate calculations. Round the final answer to 2 decimal places.) Expected return b. What is the variance of a portfolio invested 25 percent each in A and B and 50 percent in C? (Do not round intermediate calculations. Round the final answer to 6 decimal places.) Variance

Explanation / Answer

Calculation of Expected Returns State of Economy Probability Return on Stock A Return on Stock B Return on Stock C Expected Return on Stock A Expected Return on Stock B Expected Return on Stock C (1) (2) (3) (4) (5) (2 x 3) (2 x 4) (2 x 5) Boom 56% 6.00% 14.00% 34.00% 3.36% 7.84% 19.04% Bust 44% 11.00% 2.00% -7.00% 4.84% 0.88% -3.08% Expected Returns: 8.20% 8.72% 15.96% a) Stocks Weights Expected Returns Weighted Expected returns Formula for weighted expected return Stock A 33.33% 8.20% 2.73% Multiply expcted Return with Weights Stock B 33.33% 8.72% 2.91% Multiply expcted Return with Weights Stock C 33.33% 15.96% 5.32% Multiply expcted Return with Weights Overall Expected Return 10.96% b) Stocks Weights Expected Returns Weighted Expected returns Formula for weighted expected return Stock A 25.00% 8.20% 2.05% Multiply expcted Return with Weights Stock B 25.00% 8.72% 2.18% Multiply expcted Return with Weights Stock C 50.00% 15.96% 7.98% Multiply expcted Return with Weights Overall Expected Return 12.21% Variance in overall expected return with equal weights Expected return 10.96% with variance as mentioned above the expected return 12.21% Variance in absolute % 1.25% Portfolio variance 11.41% 1.25%/10.96%

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