1. If the economy booms, RTF, Inc. stock is expected to return 15%. If the econo
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Question
1. If the economy booms, RTF, Inc. stock is expected to return 15%. If the economy goes into a recessionary period, then RTF is expected to only return 3%. The probability of a boom is 60% while the probability of a recession is 40%. What is the variance of the returns on RTF, Inc. stock?
2. The Rotor Co. stock is expected to earn 16% in a recession, 7% in a normal economy, and lose 3% in a booming economy. The probability of a boom is 20% while the probability of a normal economy is 55% and the chance of a recession is 25%. What is the expected rate of return on this stock?
Explanation / Answer
1. Expected return = 60%*15% + 40%*3%= 10.20%
Variance = (60%*(15%-10.2%)^2 + 40%*(3%-10.2%)^2)=0.003456
2. expected rate of return on this stock = 16%*25% + 7%*55% + (-3%)*20%= 7.25%
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