The rate of return on the common stock of Flowers by Flo is expected to be 14% in a boom economy, 8% in a normal economy, and only 2% in a recessionary economy. The probabilities of these economic states are 20% for a boom, 70% for a normal economy, and 10% for a recession. What is the variance of the returns on the common stock of Flowers by Flo?
A) 0.001044
B) 0.001280
C) 0.001863
D) 0.002001
E) 0.002471

Question

Quizplus · Accepted Answer

The expected return is calculated as (0.20 * 0.14) + (0.70 * 0.08) + (0.10 * 0.02) = 0.086. The variance is calculated using the formula: Variance = Σ [P(i) * (R(i) - E(R))^2], where P(i) is the probability of state i, R(i) is the return in state i, and E(R) is the expected return. Calculating this gives: 0.20 * (0.14 - 0.086)^2 + 0.70 * (0.08 - 0.086)^2 + 0.10 * (0.02 - 0.086)^2 = 0.001044.

The Rate of Return on the Common Stock of Flowers