Question

Remember, the expected value of a probability distribution is a statistical measure of the average (mean) value expected to occur during all possible circumstances. To compute an asset's expected return under a range of possible circumstances (or states of nature), multiply the anticipated return expected to result during each state of nature by its probability of occurrence. Consider the following case: Rajiv owns a two-stock portfolio that invests in Falcon Freight Company (FF) and Pheasant Pharmaceuticals (PP). Three-quarters of Rajiv's portfolio value consists of Falcon Freight's shares, and the balance consists of Pheasant Pharmaceuticals'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 20% FF PP Strong Normal 35% 45% 30% 18% -24% 42% 24% -30% Weak Calculate expected returns for the individual stocks in Rajiv's portfolio as well as the expected rate of return of the entire portfolio over the three possible market conditions next year.

drop down 1 options: 1.50%, 2.03%, 1.27%, or 1.80%

drop down 2 options: 3.73%, 2.15%, 3.30%, 4.09%

drop down 3 options: 2.63%, 2.34%, 1.66%, 1.95%

Answer 1

The expected rate of return on Falcon Freight's stock over the next year is

Sum (prob. Of Occurrence *ER at that mkt.condition)

ie. (20%*30%)+(35%*18%)+(45%*-24%)=

1.5%

Answer:1

The expected rate of return on Pheasant Pharmaceuticals's stock over the next year is

(20%*42%)+(35%*24%)+(45%*-30%)=

3.30%

Answer:3

The expected rate of return on Rajiv's portfolio over the next year is

(Wt.FF*ER FF)+(Wt.PP* ER PP)

ie.(3/4*1.5%)+(1/4*3.3%)=

1.95%

Answer:4

1. TRUE

Company A has smaller standard deviation

ie. Dispersion of actual returns around the mean return is much smaller for Co.A , compared to Co. B