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P8-15 (similar to) Question Hep Expected return. Hull Consutants, a famous think tank in the Midwest, has provided probabilit
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Investment Expected returns
Stock 4.26%
Corporate bond 6.10%
Government bond 5.10%
  • Stock:
State of economy Probability Stock (Return) (%) Stock Expected Return (%)
i ii i × ii
Boom 0.11               24.00 2.64
Stable growth 0.20               12.00 2.40
Stagnant 0.51                 2.00 1.02
Recession 0.18             (10.00) -1.80
EXPECTED RETURN 4.26
  • Corporate bond:
State of economy Probability Corporate bond (Return) (%) Corporate bond Expected Return (%)
i ii i × ii
Boom 0.11                       10.00 1.10
Stable growth 0.20                         7.00 1.40
Stagnant 0.51                         6.00 3.06
Recession 0.18                         3.00 0.54
EXPECTED RETURN 6.10
  • Government bond:
State of economy Probability Government bond (Return) (%) Government bond Expected Return (%)
i ii i × ii
Boom 0.11                               9.00 0.99
Stable growth 0.20                               6.00 1.20
Stagnant 0.51                               5.00 2.55
Recession 0.18                               2.00 0.36
EXPECTED RETURN 5.10
  • The expected return from a security is calculated by multiplying forecasted returns of a security by the probabilities of those returns.
    • Expected return = Sum (Probability × Return)
      • Probability = estimated probability of occurrence of each outcome
      • Return = forecasted return in each scenario
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