Question

The rate of return on the common stock of Flowers by Flo is expected to be 14 percent in a boom economy, 8 percent in a normal economy, and only 2 percent in a recessionary economy. The probabilities of these economic states are 20 percent for a boom, 70 percent for a normal economy, and 10 percent for a recession. What is the variance of the returns

Answer 1

the variance is 0.001044

Step-by-step explanation:

The computation of the variance of the returns is shown below:

But before that expected return to be determined

E(r) = Sum of (probabilities × expected return)

= 0.20 × .14 + 0.70 × 0.08 + 0.10 × 0.02

= 0.086

Now

variance = Sum of (individual return - mean return)^2

= 0.20 × (0.14 -0.086)^2 + 0.7 × (0.08 - 0.086)^2 + 0.10 × (0.02 - 0.086)^2

= 0.001044

hence the variance is 0.001044