9. The stock of Kramer\'s Machine Shop has an expected return of 3.3%. Given the

Question

9.

The stock of Kramer's Machine Shop has an expected return of 3.3%. Given the information below, what is the expected return on this stock if the economy booms?

                                                             Probability

                        State of                         of State of                     Rate of

                        Economy                      Economy                     Return

                        Recession                         0.35                           -0.04

                        Normal                               0.60                            0.07

                        Boom                                  0.05                                ?

8.6%

10.0%

10.69%

10.48%

9.2%

8.6%

10.0%

10.69%

10.48%

9.2%

Explanation / Answer

Rp=Pa×Ra+Pb×Rb+Pc×Rc

Rp is return on portfolio

P is probability of respective portfolios

R is return on respective portfolios

3.3% = 0.35×-0.04+0.60×0.07+0.05×X

Rate of return on boom, X = 10%

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