Consider the following information: Rate of Return if State OccursState of Economy Probability of State of Economy Stock A Stock BRecession 0.15 0.07 − 0.24 Normal 0.55 0.16 0.21 Boom 0.30 0.27 0.26 Calculate the expected return for each stock. (Do not round intermediate calculations. Round the final answers to 2 decimal places.)
Question
Consider the following information: Rate of Return if State OccursState of Economy Probability of State of Economy Stock A Stock BRecession 0.15 0.07 − 0.24 Normal 0.55 0.16 0.21 Boom 0.30 0.27 0.26 Calculate the expected return for each stock. (Do not round intermediate calculations. Round the final answers to 2 decimal places.)
Solution
To calculate the expected return for each stock, we need to multiply the rate of return of each state by the probability of that state, and then sum up these products.
For Stock A:
Expected Return = (0.15 * 0.07) + (0.55 * 0.16) + (0.30 * 0.27)
= 0.0105 + 0.088 + 0.081
= 0.1795 or 17.95% when rounded to two decimal places.
For Stock B:
Expected Return = (0.15 * -0.24) + (0.55 * 0.21) + (0.30 * 0.26)
= -0.036 + 0.1155 + 0.078
= 0.1575 or 15.75% when rounded to two decimal places.
So, the expected return for Stock A is 17.95% and for Stock B is 15.75%.
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