1. Statistical measures of standalone risk Aa Aa Remember, the expected value of
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1. Statistical measures of standalone risk Aa Aa Remember, the expected value of a probability distribution is a statistical measure of the average (mean) value expected to occur during all possible circumstances. To compute an asset's expected return under a range of possible circumstances (or states of nature), multiply the anticipated return expected to result during each state of nature by its probability of occurrence. Consider the following case: James owns a two-stock portfolio that invests in Happy Dog Soap Company (HDS) and Black Sheep Broadcasting (BSB). Three-quarters of James's portfolio value consists of HDS's shares, and the balance consists of BSB's shares. Each stock's expected return for the next year will depend on forecasted market conditions. The expected returns from the stocks in different market conditions are detailed in the following table: Market Condition Probability of Occurrence Happy Dog Soap Black Sheep Broadcasting Strong Normal Weak 50% 25% 25% 28% 17% 22% 3990 22 % 28% Calculate expected returns for the individual stocks in James's portfolio as well as the expected rate of return of the entire portfolio over the three possible market conditions next year. . The expected rate of return on Happy Dog Soap's stock over the next year is . The expected rate of return on Black Sheep Broadcasting's stock over the next year is . The expected rate of return on James's portfolio over the next year is 18.00% 22.32% 11.70% 20.34%Explanation / Answer
expected returns
Happy Dog Soap: 0.5*28%+0.25*17%+0.25*(-22%)=12.75%
Black Sheep Broadcasting: 0.5*39%+0.25*22%+0.25*(-28%)=18%
Weight of Happy Dog Soap=3/4=0.75
Weight of Black SHeep Broadcasting=1/4=0.25
Expected returns of James' portfolio=0.75*12.75%+0.25*18%=14.0625%
Company A has lower risk due to thin tails
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