You recently purchased a stock that is expected to earn 19% in a booming economy, 8% in a normal economy and lose 3% in a recessionary economy. There is a 25% probability of a boom, a 60% chance of a normal economy, and a 15% chance of a recession. What is your expected rate of return on this stock
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The expected return of an asset is the summation of the probability of each state multiplied by expected rate of return. So, expected rate of return on this stock will be:-
E
(
R
)
=
Σ
P
r
o
b
a
b
i
l
i
t
y
×
E
x
p
e
c
t
e
d
r
e
t
u
r
n
E
(
R
)
=
0.15
(
0.12
)
+
0.75
(
0.08
)
+
0.10
(
−
0.05
)
E
(
R
)
=
0.073
E
(
R
)
=
7.3
%
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