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19 February, 07:26

The common stock of Manchester & Moore is expected to earn 14 percent in a recession, 7 percent in a normal economy, and lose 4 percent in a booming economy. The probability of a boom is 15 percent while the probability of a recession is 5 percent. What is the expected rate of return on this stock?

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  1. 19 February, 09:10
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    5.7%

    Explanation:

    The computation of the expected rate of return is shown below:

    = (Expected return of the boom * weightage of boom) + (expected return of the normal economy * weightage of normal economy) + (expected return of the recession * weightage of recession)

    = (15% * - 4%) + (7% * 80%) + (5% * 14%)

    = - 0.6% + 5.6% + 0.7%

    = 5.7%

    We simply multiply the weightage with each its expected return

    The weightage of the normal economy is

    = 100% - 15% - 5%

    = 80%
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