Question

You recently purchased a stock that is expected to earn 24 percent in a booming economy, 13 percent in a normal economy, and lose 2 percent in a recessionary economy. There is a 24 percent probability of a boom, a 61 percent chance of a normal economy, and a 15 percent chance of a recession. What is your expected rate of return on this stock?

(a) 2.86 percent

(b) 13.39 percent

(c) 12.33 percent

(d) 6.70 percent

(e) 11.67 percent

Answer 1

The correct answer is option (b) 13.39 percent.

Step-by-step explanation:

To calculate the expected rate of return on the stock, we need to multiply the expected rate of return in each economic condition by the probability of that condition occurring, and then sum up all the results. Let's do the calculations:

Expected return = (Boom rate * Boom probability) + (Normal rate * Normal probability) + (Recession rate * Recession probability)

Expected return = (24% * 24%) + (13% * 61%) + (-2% * 15%)

Expected return = 5.76% + 7.93% + (-0.3%)

Expected return = 13.39%

Therefore, the expected rate of return on this stock is 13.39 percent.