You are comparing Stock A to Stock B. Given the following information, what is the difference in the expected returns of these two securities? $$\begin{array} { l c c }
{ \text { State of } } & \text { Probability of } & \text { Rate of Return } \
\text { Econony } & \text { State of Economy } & \text { if State Occurs } \
& &\begin{array}{ll}\text { Stock A } & \text { Stock B }\end{array}\
\text { Normal } & .75 & \begin{array}{ll}.13 & \quad \quad .16\end{array} \
\text { Recession } & .25 &\begin{array}{ll} -05 & \quad \quad - . 21\end{array}
\end{array}$$
A) 5.25 percent
B) 1.75 percent
C) 3.05 percent
D) 2.45 percent
E) 1.55 percent

Question

You are comparing Stock A to Stock B. Given the following information, what is the difference in the expected returns of these two securities? $$\begin{array} { l c c } 
 { \text { State of } } & \text { Probability of } & \text { Rate of Return } \
\text { Econony } & \text { State of Economy } & \text { if State Occurs } \
 &  &\begin{array}{ll}\text {   Stock A } & \text { Stock B }\end{array}\
\text { Normal } & .75 & \begin{array}{ll}.13 &  \quad  \quad .16\end{array} \
\text { Recession } & .25 &\begin{array}{ll} -05 &  \quad  \quad - . 21\end{array}
\end{array}$$
A) 5.25 percent
B) 1.75 percent
C) 3.05 percent
D) 2.45 percent
E) 1.55 percent

Quizplus · Accepted Answer

The expected return for each stock is calculated by multiplying the rate of return in each state of the economy by the probability of that state occurring and then summing these products. For Stock A: $0.75 \times 0.13 + 0.25 \times (-0.05) = 0.0975 - 0.0125 = 0.085$ or 8.5%. For Stock B: $0.75 \times 0.16 + 0.25 \times (-0.21) = 0.12 - 0.0525 = 0.0675$ or 6.75%. The difference in expected returns is $8.5\% - 6.75\% = 1.75\%$.

You Are Comparing Stock a to Stock B A) 525 Percent B) 1

You Are Comparing Stock a to Stock B A) 525 Percent
B) 1