Question

You have done your research for the following investments and your friend has provided their expectations for the markets for next year. Probability of State of State of Stock Stock Economy Economy А B TSX Boom .30 30% -9% 18% Normal .40 16% 12% 10% Recession .30 -10% 20% -10% * Remember to show all of your work *

Answer 1

Expected Return (M+= [E(P*X)] Standard Deviation ( = V[3(P*(X-X)^2)] Where X is the Return of Asset X is the Mean Pis the probability STOCK A: State of Probabili Product Return(A) Economy ty(P) (P*A) Boom 0.30 0.30 0.0900 Normal 0.40 0.16 0.0640 Recession 0.30 -0.10 -0.0300 TOTAL 0.1240 Expected Return A = 12.40% Product (P*B) -0.0270 STOCKB: State of Probabili Return(B) Economy ty() Boom 0.30 -0.09 Normal 0.40 0.12 Recession 0.30 0.20 TOTAL Expected Return B = 8.1% 0.0480 0.0600 0.0810 W1 be the weight of investment in Stock A W2 be the weight of investment in Stock B So, W1 +W2 = 1 that means, W1 = 1 - W2 expected return of portfolio cosists of stock A and Stock B; 0.15= 0.124*W1 +0.081*W2 W1 value substite in above equation 0.15 = 0.124*(1-W2) + 0.081*W2 0.15 = 0.124 -0.0124*W2 +0.081W2 0.15 = 0.124 - 0.043*W2 W2 = -60.47% Therefore, W1 = 160.47% Take the loan of $6047 @ 8.10% and invest $16047 in stock A