Consider the following information: State of Prob of State Rate of Return if Sta

Question

Consider the following information:    

State of            Prob of State         Rate of Return if State Occurs

Economy         of Economy       Stock A        Stock B         Stock C

Boom                   .35                    .07                .15                   .33

            Bust                     .65                    .13                .03                 -.06

            What is and expected return and variance of a portfolio which is equally weighted in investments of each of the three stocks?

Explanation / Answer

computation of expected return and variance

boom

particulars probability expected return

stock A 0.35 0.07

stock B 0.35 0.15

stock C 0.35 0.33

expected return = 0.35 * 0.07 + 0.35 * 0.15 + 0.35 * 0.33

= 0.0245 + 0.0525 + 0.1155

= 19.25%

bust

computation of expected return and variance

particulars probability expected return

stock A 0.65 0.13

stock B 0.65 0.03

stock C 0.65 - 0.06

expected return = 0.65 * 0.13 + 0.65 * 0.03 + 0.65 * -0.06

= 6.5%.

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