You own a portfolio of 5 stocks and have 3 expected states of the economy. You have twice as much invested in Stock A as you do in Stock E. How will the weights be determined when you compute the rate of return for each economic state?
A)The weights will be the probability of occurrence for each economic state.
B)Each stock will have a weight of 20% for a total of 100%.
C)The weights will decline steadily from Stock A to Stock E.
D)The weights will be based on the amount invested in each stock as a percentage of the total amount invested.
E)The weights will be based on a combination of the dollar amounts invested as well as the economic probabilities.

Question

Quizplus · Accepted Answer

The weights will be based on the amount invested in each stock as a percentage of the total amount invested. This method is commonly referred to as the market value weights. Since the question states that there is twice as much invested in Stock A as in Stock E, the weights will not be equal and will be based on the dollar amounts invested. The economic probabilities are not mentioned as a factor in determining the weights, so option E is not the best choice. Option A is incorrect because the weights are not solely based on the probability of occurrence for each state. Option B is incorrect because the weights are not equal. Option C is incorrect because there is no information given to suggest that the weights decline steadily from Stock A to E.

You Own a Portfolio of 5 Stocks and Have 3