Barbara is considering investing in a stock and is aware that the return on that

Question

Barbara is considering investing in a stock and is aware that the return on that investment is particularly sensitive to how the economy is performing. Her analysis suggests that four states of the economy can affect the return on the investment. Using the table of returns and probabilities below, find

Probability         Return

Boom

  0.4            

25.00%

Good

0.3

15.00%

Level

0.1

10.00%

Slump

0.2

-5.00%

Probability         Return

Boom

  0.4            

25.00%

Good

0.3

15.00%

Level

0.1

10.00%

Slump

0.2

-5.00%

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Expected Return on Investment (formula) = Probability of Boom Economy*Return Under Boom Economy + Probability of Good Economy*Return Under Good Economy + Probability of Level Economy*Return Under Level Economy + Probability of Slump Economy*Return Under Slump Economy

Expected Return on Investment = .4*25 + .3*15 + .1*10 + .2*-5 = 14.50%

Answer is 14.50%.

Thanks.

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