ronnie estimates that there are three possible return outcomes for a stock he is

Question

ronnie estimates that there are three possible return outcomes for a stock he is considering for purchase. He thinks there is a 25% chance the economy will boom and his stock will return 25%, a 50% chance the economy will continue at its current pace and the stock will return to 8%, and finally, that there is a 25% chance that the economy will falter and the expected return on his stock will be 0%. Given these profabilities and conditional expected returns, what is ronnies expected return on the stock he is considering for purchase.

Explanation / Answer

Ronnies expected return on the stock = Probability at the time of boom*Stock return in Boom + Probability at the time of Normal*Stock return in Normal + Probability at the time of falter*Stock return in falter

Ronnies expected return on the stock = 25%*25 + 50%*8 + 25%*0

Ronnies expected return on the stock = 10.25%

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