Question

Following table shows information of future probable economic conditions and associated returns for the Apple and Walmart stocks.

Economic Condition	Probability	Return
		Apple	Walmart
Excellent	0.15	0.30	0.14
Good	0.35	0.18	0.08
Poor	0.25	-0.03	-0.01
Crash	0.25	-0.12	-0.04

Calculate expected returns of Apple and Walmart.

Calculate standard deviation of the returns of Apple and Walmart.

If you want to minimize your risk, which stock would you choose and why?

How might the equity market react to each of the following conditions and why?

a) Increasing interest rate

b) Increasing inflation

Answer 1

Economic Condition	Probability (p)	Return		p*r1	p*r2	Prob*(r1-expected return)^2	Prob*(r2-expected return)^2
		Apple (r1)	Walmart (r2)	Apple	Walmart	Apple	Walmart
Excellent	0.15	0.3	0.14	0.045	0.021	0.008	0.002
Good	0.35	0.18	0.08	0.063	0.028	0.004	0.001
Poor	0.25	-0.03	-0.01	-0.0075	-0.0025	0.003	0.001
Crash	0.25	-0.12	-0.04	-0.03	-0.01	0.009	0.001
			Expected Return	0.0705	0.0365

a) Expected Returns- Apple: 0.0705 and Walmart: 0.0365

b) Apple Walmart

Variance	0.024	0.004
SD	0.154	0.065

Variance is the sum of Prob*(r-expected return)^2

c) When it comes to risk, SD is a measure of risk

If I want to minimize the risk, I would choose Walmart stock which has lesser SD

When IR increase and Inflation rises, the consumer sentiment is affected and spending reduces

So, market reacts negatively

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