Question

For an asset A we assume with a 28.31% probability that it does well in the current economic environment. In that case the expected return is 16.82%, otherwise it is 3.58%. Furthermore, we have an asset B for which we expect the following: 24.97% return with 5.25% probability, 8.67% return with a 71.11% probability and 1.15% return otherwise. If we create a portfolio consisting of 62.01% of asset A and the remainder in asset B, what is the expected return of this portfolio? (answer as a percentage)

Answer 1

Expected return of asset A= sum of (probability* return of A)

=.2831*16.82 +(1-.2831)*3.58 =7.328%

Expected return of asset B = sum of (probability* return of B)

=.0525*24.97 +.7111*8.67 +(1-.0525-.7111)*1.15 =7.748

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Expected return of portfolio= sum of (weight of asset*return of asset)

=.6201*7.328 +(1-.6201)*7.748 =7.487%