Question 5 (4 points) Use the following information to answer the two questions

Question

Question 5 (4 points) Use the following information to answer the two questions below. State of the economy Boom Bust Prob. of the Rate of return if state occurs state of economy Stock AStock B 0.70 0.20 0.02 0.30 -0.10 0.02 You MUST use 4 digits in every calculation you do in order for your answer to be the same as the one in the system. Enter answer using 4 decimals. What is the expected return of a portfolio with equal investments in each asset? abs What is the variance of the portfolio with equal investments in each asset? Save

Explanation / Answer

Stock A return = 0.70 * 20% + 0.3 * (-10%)

Stock A return = 14% - 3%

Stock A return = 11%

Stock B return = 0.70 * 2% + 0.3 * (2%)

Stock B return = 2%

Stock B return = 2%

Portfolio Return = 0.5 * 11% + 0.5 * 2%

Portfolio Return = 6.5%

Part B:

Variance:

Expected Return in Boom = 0.5 * 20% + 0.5 * 2%

Expected Return in Boom = 11%

Expected Return in Bust = 0.5 * (-10%) + 0.5 * 2%

Expected Return in Bust = -4%

Expected Return of Portfolio = 0.7 * 11% + 0.3 * (-4%)

Expected Return of Portfolio = 7.7% - 1.2%

Expected Return of Portfolio = 6.5%

Variance = 0.7 * (11% - 6.5%)2 + 0.3 * (-4% - 6.5%)2

Variance = 0.0047

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