Assume that the economy can experience high growth, normal growth, or recession.

Question

Assume that the economy can experience high growth, normal growth, or recession. Under these conditions, you expect the following stock market returns for the coming year: Compute the expected value of a $1,000 investment over the coming year. If you invest $1,000 today, how much money do you expect to have next year?__________What is the percentage expected rate of return?___________Compute the standard deviation of the percentage return over the coming year.___________If the risk-free return is 7 percent, what is the risk premium for a stock market investment?___________

Explanation / Answer

Expected money next year = 1000*(1+(0.2*65%+0.7*18%-0.1*20%))

Expected money next year = $1236

% Expected return= 0.2*65%+0.7*18%-0.1*20%= 23.6%

Variance= 0.2*(65%-23.6%)2 +0.7*(18%-23.6%)2 +0.1*(-20%-23.6%)2=0.05548

Standard Deviation= Sqrt(Variance)= 0.2355

Standard Deviation of returns = 23.55%

Risk premium= 23.6%-7%

Risk premium=16.6%

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