1-The returns on the common stock of New Image Products are quite cyclical. In a

Question

1-The returns on the common stock of New Image Products are quite cyclical. In a boom economy, the
stock is expected to return 32 percent in comparison to 14 percent in a normal economy and a negative
28 percent in a recessionary period. The probability of a recession is 25 percent while the probability of a
boom is 20 percent. What is the standard deviation of the returns on this stock?

2- the risk-free rate of return is 3.9 percent and the market risk premium is 6.2 percent. what is the expected rate of return on a stock with a beta of 1.21?

Explanation / Answer

Mean of return = (0.2*32+0.55*14-0.25*28)/3 = 2.367 %

Variance of returns = (32-2.367)^2 * 0.2 + (14-2.367)^2 * 0.55 + (-28-2.367)^2 * 0.25 = 480.59 percent points

Std deviation of returns = 21.92 %

part B:

Expected return = Risk free rate + Market premium * Beta = 3.9 + 6.2 * 1.21 = 11.42 %

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