You recently purchased a stock that is expected to earn 17 percent in a booming

Question

You recently purchased a stock that is expected to earn 17 percent in a booming economy, 12 percent in a normal economy, and lose 5 percent in a recessionary economy. There is a 17 percent probability of a boom, a 66 percent chance of a normal economy, and a 17 percent chance of a recession. What is your expected rate of return on this stock? What is the beta of a portfolio comprised of the following securities? The common stock of Flavorful Teas has an expected return of 21.42 percent. The return on the market is 15 percent and the risk-free rate of return is 4.3 percent. What is the beta of this stock?

Explanation / Answer

Answer:

7.

Return = Probability * Return

8.

Beta = 1.358

9.

Using CAPM model = Risk free rate + beta * (Market return - Risk free rate)

21.42% = 4.3% + B * (15% - 4.3%)

Beta = 1.60

Condition Probability Return Booming 17% 17% Normal 66% 12% Recession 17% -5% Expected return = 9.96%

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