Question

2. Statistical measures of stand-alone risk 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: David owns a two-stock portfolio that invests in Celestial Crane Cosmetics Company (CCC) and Lumbering Ox Truckmakers (LOT). Three-quarters of David's portfolio value consists of CCC's shares, and the balance consists of LOT'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: Probability of Occurrence 0.25 Market Condition Strong Normal Weak Celestial Crane Cosmetics 32.5% 19.5% Lumbering Ox Truckmakers 45.5% 0.45 26% -32.5% 0.30 -26% Calculate expected returns for the individual stocks in David's portfolio as well as the expected rate of return of the entire portfolio over the three possible market conditions next year. • The expected rate of return on Celestial Crane Cosmetics's stock over the next year is • The expected rate of return on Lumbering Ox Truckmakers's stock over the next year is • The expected rate of return on David's portfolio over the next year is

Answer 1

Expected rate of return Crane Cosmetics 9.10% -32.5%*0.25+19.5%*0.45-26%*0.3 Expected rate of return Lumbering Ox Truckmakers 13.33% -45.5%*0.25+26%*0.45-32.5%*0.3 Expected rate of return Portfolio 10.16% -9.1%*3/4+13.33%*1/4 Correct option is "Company H has lower risk"

*Please rate thumbs up