You recently purchased a stock that is expected to earn 19 percent in a booming economy, 12 percent in a normal economy, and lose 8 percent in a recessionary economy. The probability of a boom economy is 16 percent while the probability of a normal economy is 78 percent. What is your expected rate of return on this stock?
A) 12.40 percent
B) 10.25 percent
C) 11.92 percent
D) 12.54 percent
E) 13.50 percent

Question

Quizplus · Accepted Answer

First, we need to calculate the expected return for each economic scenario:

Expected return in a booming economy: 19%
Expected return in a normal economy: 12%
Expected return in a recessionary economy: -8%

Next, we calculate the overall expected return by weighting the scenario returns by their respective probabilities:

Expected return = (0.16 x 0.19) + (0.78 x 0.12) + (0.06 x -0.08) = 0.0304 + 0.0936 - 0.0048 = 0.1192 = 11.92%

Therefore, the expected rate of return on this stock is 11.92%. The answer is C.

You Recently Purchased a Stock That Is Expected to Earn