Consider the following information on a portfolio of these stocks: State of Econ
ID: 2651681 • Letter: C
Question
Consider the following information on a portfolio of these stocks:
State of Economy
Probability of State of Economy
Stock A Rate of Return
Stock B Rate of Return
Stock C Rate of Return
Boom
.15
.05
.21
.18
Nominal
.80
.08
.15
.07
Bust
.05
.12
-.22
-.02
The portfolio is invested 35% in each Stock A and Stock B and 30% in Stock C. If the expected T-bill rate is 3.90%, what is the expected risk premium on the portfolio? (Please show how you came up with the answer - thank you)
State of Economy
Probability of State of Economy
Stock A Rate of Return
Stock B Rate of Return
Stock C Rate of Return
Boom
.15
.05
.21
.18
Nominal
.80
.08
.15
.07
Bust
.05
.12
-.22
-.02
Explanation / Answer
Expected return on stock A = (.15*.05)+(.80*.08)+(.05*.12)
= .0075+.064+.006=.0775 or 7.75%
Expected return on stock B=(.15*.21)+(.80*.15)+(.05*-.22)
=.0315+.12-.011
=.1405 or 14.05%
Expected return on stock C=(.15*.18)+(.80*.07)+(.05*-.02)
= .027+.056-.001
=.082 or 8.20%
Return in market:
Risk premium =Return on market - Risk free rate
= 10.09 -3.90
= 6.19%
Stock Weights(A) return (B) weighted return(A*B) A .35 7.75 2.7125 B .35 14.05 4.9175 C .30 8.20 2.46 Return on market 10.09%Related Questions
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