Question

Consider the following information on a portfolio of three stocks: State of of Economy " Probability of Economy .15 State of 15 points Boom Normal Bust Stock A Stock B 1 Stock Rate of Return Rate of Return Rate of Return .04 .33 -55 .09 .15 -14 - 28 .19 25 a. If your portfolio is invested 40 percent each in A and B and 20 percent in C, what is the portfolio's expected return? The variance? The standard deviation? (Do not round intermediate calculations. Round your variance answer to 5 decimal places, e.g., 16161. Enter your other answers as a percent rounded to 2 decimal places, e.g., 32.16.) b. If the expected T-bill rate is 3.75 percent, what is the expected risk premium on the portfolio? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Answer is complete but not entirely correct. % Expected return Variance Standard deviation Expected risk premium 10.56 0.01345 11.60 6.81 b. % %

Answer 1

State of	Probability of
Economy	State of Economy		Stock A		Stock B			stock C
Boom		0.15		0.04		0.33		0.55
good		0.6		0.09		0.13		0.19
bust		0.25		0.15		-0.14		-0.28
		weight		0.4		0.4		0.2
		return		0.0975		0.0925		0.1265
		weight * return		0.039		0.037		0.0253
		Expected return of portfolio E(X)	10.13%
		weight * return^2		0.0038025		0.0034225		0.00320045
		E(X^2)	0.01042545
		variance of portfolio	0.00016
		standard deviation of portfolio	1.28%

b)

risk premium = return - risk free rate

= 10.13% - 3.75%

= 6.38%