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9 March, 18:54

You recently purchased a stock that is expected to earn 12% in a booming economy, 8% in a normal economy and lose 5% in a recessionary economy. There is a 15% probability of a boom, a 75% chance of a normal economy, and a 10% chance of a recession. What is your expected rate of return on this stock

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  1. 9 March, 18:55
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    The expected return on this stock is 7.3%

    Explanation:

    Using the expectations model, we can calculate the expected return on the stock based on the return on stock in different scenarios/states and the probability of those states.

    The expected return on the stock is,

    Expected r = rA * pA + rB * pB + rC * pC

    Where,

    r represents the returns in each state p represents the probability of each state

    Expected r = 0.12 * 0.15 + 0.08 * 0.75 + (-0.05 * 0.1)

    Expected r = 0.073 or 7.3%
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