Security Returns If State Occurs State of Probability of Economy State of Econom

Question

       Security Returns If State Occurs
State of   Probability of  
Economy   State of Economy   Roll     Ross   
Bust   .30   -18   %   18   %
Boom     .70   17      5     

Calculate the expected returns for Roll and Ross by filling in the following table (verify your answer by expressing returns as percentages as well as decimals): (Negative values should be indicated by a minus sign. Do not round intermediate calculations. Round your E(R) answers to 2 decimal places and your Product answers to 4 decimal places. Omit the "%" sign in your response.)

       Roll      Ross     
     
   

State of Economy   Probability of
State of Economy   Return If
State Occurs   Product      Return if
State Occurs   Product     
Bust   .30       %              %         
Boom   .70       %              %         
            
      
       E(R) =        %   E(R) =        %
         
      

Explanation / Answer

Expected return is the likely return from a security in the coming year. It is estimated when decision making environment is risky. In certain environment all input figures are known with certainty. Hence the result calculated is sure to happe. In this environment all persos will take unanimous decision.

Certainty environment is rarely found. Mostly you have to take decision in a risky environment. In this situation you will get more than one alternative situation. The probability of occurance of each evironment is also assessable. On the basis of available information you have to estimate expected return. It is the sum of the product of return of a situation ad its correspondig probabilty.

--------------------------------------------------------------------------------------------------------------------------------------

The problem has two securities Roll and Ross. There are two different state of the economy. They are Bust and boom. There probabilities of occurance are 0.30 and 0.70. Possible return of two securities under these two evironment are also mentioned. Calculatio of expected returns are show in the table below:

Answer: E(R) of Roll = 6.5%; E(R) of Ross = 8.9%

State of economy Probability Returns Expected value Roll Ross Roll Ross Bust 0.30 -18% 18% -18%x0.3=-5.4% 18%x0.3=5.4% Boom 0.70 17% 5% 17%x0.7=11.9% 5%x0.7=3.5% Expected Return -5.4%+11.9%=6.5% 5.4%+3.5%=8.9%

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.