Question

You recently purchased a stock that is expected to earn 20 percent in a booming economy, 15 percent in a normal economy, and lose 2 percent in a recessionary economy. There is 21 percent probability of a boom, 72 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

rE = 0.1486 or 14.86%

Step-by-step explanation:

The expected rate of return of a stock is the mean return that is expected to be earned by the stock considering the different scenarios that can occur, the return in these scenarios and the probability of the occurrence of these scenarios. The formula for expected rate of return of stock is,

rE = pA * rA + pB * rB + ... + pN * rN

Where,

• pA, pB, ... represents the probability that scenario A, B and so on will occur or the probability of each scenario
• rA, rB, ... represents the return in scenario A, B and so on

rE = 0.21 * 0.2 + 0.72 * 0.15 + 0.07 * -0.02

rE = 0.1486 or 14.86%