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1. Stock A has the following returns for various states of the economy:
State of
the Economy            Probability         Stock A's Return
Recession                10%                   -30%
Below Average        20%                   -5%
Average                   40%                    8%
Above Average        25%                    25%
Boom                        5%                     50%

Stock A's expected return is:

a)8.75%

b)48%

c)7.95%

d)9.6%

Explanation / Answer

The expected return can be calculated with the use of following formula:

Expected Return = Probability of Recession*Expected Return under Recession + Probability of Below Average*Expected Return under Below Average + Probability of Average*Expected Return under Average + Probability of Above Average*Expected Return under Above Average + Probability of Boom*Expected Return under Boom

___________

Solution:

Using the values provided in the question, we get,

Stock A's Expected Return = 10%*-30% + 20%*-5% + 40%*8% + 25%*25% + 5%*50% = 7.95% (which is Option C)

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