Consider the following information: Calculate the expected return for the two st

Question

Consider the following information:

Calculate the expected return for the two stocks. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places. Omit the "%" sign in your response.)

Calculate the standard deviation for the two stocks. (Do not round your intermediate calculations. Enter your answers as a percent rounded to 2 decimal places. Omit the "%" sign in your response.)

Rate of Return If State Occurs State of Probability of Economy State of Economy Stock A Stock B   Recession .35 .07 –.17   Normal .40 .09 .16   Boom .25 .13 .36

Explanation / Answer

a) Expected return :

For Stock A - 0.35*0.07 + 0.4*0.09 + 0.25*0.13 = 0.0245 + 0.0036 + 0.0325 = 0.0606 or 6.06%

For Stock B - 0.35*-0.17 + 0.4*0.16 + 0.25*0.36 = -0.0595 + 0.064 + 0.09 = 0.0945 or 9.45%

b) Variance for A :

0.35* (0.07-0.0606)^2 + 0.4*(0.09-0.0606)^2 + 0.25* (0.13-0.0606)^2 = 0.00003 + 0.00003 + 0.0012 =0.00126

Standard deviation = (Variance)^0.5 = 0.03549 or 3.549%

Variance for B:

0.35*(-0.17-0.0945)^2 + 0.4*(0.16-0.0945)^2 + 0.25*(0.36-0.0945)^2 = 0.09257 + 0.0017 + 0.0176 = 0.11187

Standard deviation = 0.3344 or 33.44%

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