ent 08- Risk and Rates of Return lashua owns a two-stock port\'oilic that invest

Question

ent 08- Risk and Rates of Return lashua owns a two-stock port'oilic that invests in Falcon Freight Compay (FF) and Pheasant Three-quarters of Jostua's portfolia value consists of FP's shares, and the balance consists of PP's shares. Each stoks expected return for the next year wll depend on forecasted from the stocks in different market conditions are detailed in the following tabie: market conditions. The expected returns Market Condition Probability ofo Falcon Freight Pheasant Pharmaceuticals 56% 24% -32% 35% 45% -40% Calaulate expected returns for the individual stocks in Jashua's portfolio as well as the expected rate of return of the entre portfclia over the three passible market conditions next year .The expected rate of return on Falcan Freight's stock over the next year is The expected rate of return on Pheasant Pharmaceuticals's stock over the next year is The expected rate of return on Joshua's portfolio over the next year is The expected returhs for Joshua's portfolio were calculated based on three possible conditions in the market. Such conditions will vary from time to time, and for each condition there will be a specific outcome. These probablities and outcomes can be represented in the form of a continuous probability distribution graph. For example, the continuous probabity distributions of rates of return on stocks for two different companies are shown on the following graph: DENSITY

Explanation / Answer

Question 1: Fill in the Blanks

Expected Return on a stock = P1 * R1 + P2 * R2 + .......... + Pn * Rn

For Falcon Freight, expected return = (20% * 40%) + (35% * 24%) + (45% * -32%) = 2.00%

For Pheasant Pharma, expected return = (20% * 56%) + (35% * 32%) + (45% * -40%) = 4.40%

For Joshua' portfolio, 3/4th is in Falcon Freight and 1/4th in Pheasant Pharma, expected return = (3/4) * 2% + (1/4) * 4.40% = 1.5% + 1.1% = 2.60%

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Question 2: Multiple Choice Question.

Company A has a tighter probability distribution. This is visible in the graph where the expected return of Company is spread over a lower x-axis range than Company B, which has higher range on x-axis.

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