Please answer all parts (a-f) and show your work Consider the following informat

Question

Please answer all parts (a-f) and show your work

Consider the following information on three stocks.                               

Rate of Return if State Occurs

State of economy

Probability of state of economy

Stock A

Stock B

Stock C

a) If your portfolio is invested 40% each in A and C, and 20% in B, what is the portfolio expected return?

b) What is the variance of this portfolio?

c) What is the standard deviation of this portfolio?

d) If the expected T-Bill rate is 5%, what is the expected risk premium on the portfolio?

e) If the expected inflation rate is 2.50%, what are the approximate and exact expected real returns on the portfolio?

f) If the expected T-Bill rate is 5% and the expected inflation rate is 2.50%, what are the approximate and exact expected real risk premiums on the portfolio?

Rate of Return if State Occurs

State of economy

Probability of state of economy

Stock A

Stock B

Stock C

Explanation / Answer

a.

Expected return = 0.40*0.147 + 0.40*0.215 +0.20*0.161 =0.177 or 17.7%.

b and C.

d.

The expected risk premium = Market return - T bill return = 0.177-0.05 = 0.127

Therefore, risk premium = 12.7%.

e.

Expected real rate of return = 0.177/1.025 = 0.17268 or 17.27%.

f.

Expected real return = 12.7/1.025 = 12.39%.

State of economy Probability(P) rate of return Expected return Stock A(x) Stock B(y) Stock C(Z) Stock A(P*x) Atock B(P*y) Atock B(P*z) Bust 0.2 0.01 -0.25 -0.5 0.002 -0.05 -0.1 Normal 0.3 0.15 0.12 0.05 0.045 0.036 0.015 Boom 0.5 0.2 0.35 0.6 0.1 0.175 0.3 Expected return of the stock 0.147 0.161 0.215

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