Stock A has the following returns for various states of the economy: State of th

Question

Stock A has the following returns for various states of the economy:

State of the Economy

Probability

Stock A's Return

Recession

9%

-72%

Below Average

16%

-15%

Average

51%

16%

Above Average

14%

35%

Boom

10%

85%

Stock A's expected return is        Answer                      

Amount Invested

8,000 shares of Stock A

$16,000

Beta = 1.3

15,000 shares of Stock B

$48,000

Beta = 1.8

25,000 shares of Stock C

$96,000

Beta = 2.2

  

State of the Economy

     

Probability

     

Stock A's Return

     

Recession

     

9%

     

-72%

     

Below Average

     

16%

     

-15%

     

Average

     

51%

     

16%

     

Above Average

     

14%

     

35%

     

Boom

     

10%

     

85%

  

Explanation / Answer

Stock A's expected return= (-72x.09)+(-15x.16)+(16x.51)+(35x.14)+(85x.10)= 12.68% or rounding will give 12.7%

Portfolio Beta= (16,000/160000x1.3)+(48,000/160000x1.8)+(96,000/160000x2.2)= 1.99

required return on the portfolio = rf+ betaxmarket risk premium

= 4%+1.99x9= 21.91%.

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