Question

Rate of Return if State Occurs Stock State of Economy Probability of State of Economy Stock A Stock B Boom 45% 0.18 0.40 0.22 Bust 55% -0.06 -0.30 -0.05 Asset Weights 25% 30% 45% What is the expected return of this portfolio?

Answer 1

Expected Return of the stock = $\sum$Probability * Return

Expected Return of the stock A = (0.45 * 0.18) + (0.55 * (-0.06)) = 0.081 - 0.033

Expected Return of the stock A = 0.048

Expected Return of the stock B = (0.45 * 0.4) + (0.55 * (-0.30)) = 0.18 - 0.165

Expected Return of the stock B = 0.015

Expected Return of the stock C = (0.45 * 0.22) + (0.55 * (-0.05)) = 0.099 - 0.0275

Expected Return of the stock C = 0.0715

Expected Return of Portfolio = $\sum$ Weight * Return of stock

Expected Return of Portfolio = (0.25 * 0.048) + ( 0.30 * 0.015) + (0.45 * 0.0715)

Expected Return of Portfolio = 0.012 + 0.0045 + 0.032175

Expected Return of Portfolio = 4.87%