You recently purchased a stock that is expected to earn 10 percent in a booming economy, 4 percent in a normal economy, and lose 4 percent in a recessionary economy. There is a 15 percent probability of a boom, a 70 percent chance of a normal economy, and a 15 percent chance of a recession. What is your expected rate of return on this stock? a. 1.85 percent b. 3.70 percent c. 10.00 percent d. 4.67 percent e. 3.33 percent

b. 3.70 percent

Explanation:

Expected rate of return of a stock, given probabilities, is calculated by summing up the product of probability of each state occurring by the expected return of the stock should that happen.

Expected rate of return = SUM (probability * return)

Boom; (probability * return) = (0.15 * 0.10) = 0.015 or 1.5%

Normal; (probability * return) = (0.70 * 0.04) = 0.028 or 2.8%

Recession; (probability * return) = (0.15 * - 0.04) = - 0.006 or - 0.6%

Next, sum up the expected return for each state of the economy to find the expected rate of return on this stock;

= 1.5% + 2.8% - 0.6%

= 3.7%

Therefore, the correct answer is choice B.