Question

The common stock of Manchester & Moore is expected to earn 13 percent in a recession, 6 percent in a normal economy, and lose 4 percent in a booming economy. The probability of a boom is 5 percent while the probability of a recession is 45 percent. What is the expected rate of return on this stock?

Answer 1

8.65%

Explanation:

Given information:

Recession Return = 13%

Normal Return = 6%

Boom Return = -4%

Probability of a recession = 45 %

Probability of a boom = 5 %

Probability of a normal = 100 - 45 - 5 = 50%

We need to find the expected rate of return on this stock.

Expected rate of return is the sum of products of probability and returns of each state of economy.

Expected rate of return
`=13\%* 45\%+6\%* 50\%+(-4\%)* 5\%`

`=5.85\%+3\%-0.2\%`

`=8.65\%`

Therefore, the expected rate of return on this stock is 8.65%.