A stock is expected to earn 36 percent in a boom economy, 20.00 percent in a nor

Question

A stock is expected to earn 36 percent in a boom economy, 20.00 percent in a normal economy, and lose 20 percent in a recessionary economy. There is a 16 percent chance the economy will boom and a 60 percent chance the economy will be normal. What is the expected risk premium for this stock if the risk-free rate is expected to be 5.40 percent?

7.27 percent

6.16 percent

6.60 percent

7.56 percent

Stock

Number of Shares

Price per Share

A

500

13

B

200

  28

C

800

  26

D

400

  15

53.47 percent

51.09 percent

56.48 percent

50.28 percent

A portfolio consists of 30 percent Stock A, 60 percent Stock B, and 10 percent Stock C. What is the portfolio expected return given the following:

State of Economy

Probability of State of Economy

Stock A Returns

Stock B Returns

Stock C Returns

Normal

0.60

22%

   15%

   38%

Recession

0.40

A stock is expected to earn 36 percent in a boom economy, 20.00 percent in a normal economy, and lose 20 percent in a recessionary economy. There is a 16 percent chance the economy will boom and a 60 percent chance the economy will be normal. What is the expected risk premium for this stock if the risk-free rate is expected to be 5.40 percent?

Explanation / Answer

Answer:-1:

Calculation of expected return of the stock:

Formula :

Expected return = (Return 1* Probability 1 ) + (Return 2* Probability 2 )+

(Return 3* Probability 3 )

= (36%*16%) + (20%*60%) + (-20%*(100-16-60)%)

= 12.96%

Expected risk premium = Expected Return on stock - Risk Free rate

=12.96% - 5.4%

=7.56%

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