Question

Consider the following case: David owns a two-stock portfolio that invests in Celestial Crane Cosmetics Company (CCC) and Lumbering Ox Truckmakers (LOT). Three-quarters of David's portfolio value consists of CCC's shares, and the balance consists of LOT's shares. Each stock's expected return for the next year will depend on forecasted market conditions. The expected returns from the stocks in different market conditions are detailed in the following table: Market Condition Probability of Occurrence Celestial Crane Cosmetics Lumbering Ox Truckmakers Strong 25% 33% 46% Normal 45% 20% 26% Weak 30% -26% -33% Calculate expected returns for the individual stocks in David's portfolio as well as the expected rate of return of the entire portfolio over the three possible market conditions next year. • The expected rate of return on Celestial Crane Cosmetics's stock over the next year is . The expected rate of return on Lumbering Ox Truckmakers's stock over the next year is • The expected rate of return on David's portfolio over the next year is

Answer 1

Expected return on CCC = 0.25 * 33% + 0.45 * 20% + 0.30* -26% = 9.45%

Expected return on Lumbering OX = 0.25* 46% + 0.45 * 26% + 0.3* -33% = 13.3%

Expected return on David's portfolio = 3/4 * 9.45% + 1/4 * 13.3% = 10.4125%

Company H exhibits greater risk because the range of rate of return is from (- 20 ,50), while the range of returns for Company G is (0,20)