Calculate the expected return for the two stocks. ( Do not round intermediate ca

Question

Calculate the expected return for the two stocks. (Do not round intermediate calculations. Enter your answers as a percentage rounded to 2 decimal places (e.g., 32.16).)

Calculate the standard deviation for the two stocks. (Do not round intermediate calculations. Enter your answers as a percentage rounded to 2 decimal places (e.g., 32.16).)

Rate of Return if State Occurs State of Probability of State Economy of Economy Stock A Stock B   Recession .20               .035          –.40            Normal .60               .115          .30            Boom .20               .290          .53         

Explanation / Answer

Solution:

Requirement 1 :

Expected Return for Stock A = (0.20*.035)+(0.60*0.115)+(0.20*0.290)

=0.007+0.069+0.058

=0.134

=13.4%

Expected Return on Stock B=( 0.20*-0.40)+(0.60*0.30)+(0.20*0.53)

=-0.08+0.18+0.106

=0.206

=20.6%

Requirement 2 :

Solution:

Standard Deviation for StockA:

Probability(P) Rate of Return Deviation from Expected Return (d) d^2 (S) S*P

0.20 0.035 -0.099 0.009801 0.0019602

0.60 0.115 -0.019 0.000361 0.0002166

0.20 0.29 0.156 0.024 0.0048

Total 0.0069768

Therefore, Standard Deviation for Stock A =(0.0069768)^1/2=8.35%

Standard Deviation for Stock B:

Probability(P) Rate of Return Deviation from Expected Return (d) d^2 (S) S*P

0.20 -0.040 0.606 0.367236 0.0734472

0.60 0.30 0.094 0.008836 0.0053016

0.20 0.53 0.324 0.104976 0.0209952

Total 0.099744

Therefore Standard Deviation for Stock B = (0.099744)^1/2 =31.58%

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