Question

You are thinking about investing your money in the stock market. You have the following two stocks in mind: stock A and stock B. You know that the economy can either go in recession or it will boom. Being an optimistic investor, you believe the likelihood of observing an economic boom is seventy five observing an economic depression. You also know the following about your two stocks: State of Probability A B Return Return Economy Boom 14% 2% Recession -4% 40% the Calculate the expected return for stock A only?

Answer 1

Answer-

Given

The likelihood of economic boom = 75 % =0.75

Therefore the likelihood of economic recession = 1 - 75 % = 1 - 0.75 = 0.25

return on stock A during economic boom = 14 %
return on stock A during economic recession = - 4 %

The expected recession on Stock A = return on stock A during economic boom x likelihood of economic boom + return on stock A during economic recession x the likelihood of economic recession

The expected recession on Stock A = 14 % x 0.75 + ( - 4 % ) x 0.25

The expected recession on Stock A = 10.5 % - 1 %

The expected recession on Stock A = 9.5 %