Question

You recently purchased a stock that is expected to earn 23 percent in a booming economy, 12 percent in a normal economy, and lose 3 percent in a recessionary economy. There is 24 percent probability of a boom, 69 percent chance of a normal economy, and 7 percent chance of a recession. What is your expected rate of return on this stock

Answer 1

Expected rate of return on this stock= 13.59 %

Step-by-step explanation:

The expected return on investment is the weighted average of all the return from possible outcomes weighted according to the probability of each outcome.

This principle would be applied as follows:

Outcome Probability(P) Return(R) P× R

Boom 0.24 × 23% = 5.52 %

Normal 0.69 × 12% = 8.28 %

Recess 0.07 × -3% = -0.21 %

Expected Return = 5.52 % + 8.28 %-0.21 % = 13.59 %

Expected rate of return on this stock= 13.59 %