Darren has the option of investing in either Stock A or Stock B. There is a 45 percent chance that the return on Stock A will be 25 percent, a 25 percent chance it will be 14 percent, and a 30 percent chance it will be 4 percent. There is a 45 percent chance that the return on Stock B will be 30 percent, a 25 percent chance it will be 9 percent, and a 30 percent chance it will be2 percent. What is the expected rates of return on Stock A and Stock B?

15.95 %

16.35 %

Explanation:

Stock A.

Given:

Return expectation r1 = 45%

Probability expectation p1 = 25%

Return expectation r2 = 25%

Probability expectation p2 = 14%

Return expectation r3 = 30%

Probability expectation p3 = 4%

Expected Rate of Return = r1p1 + r2p2 + r3p3 ...

= (45% x 25%) + (25% x 14%) + (30% x 4%)

= 11.25% + 3.5% + 1.2%

= 15.95 %

Stock B.

Given:

Return expectation R1 = 45%

Probability expectation P1 = 30%

Return expectation R2 = 25%

Probability expectation P2 = 9%

Return expectation R3 = 30%

Probability expectation P3 = 2%

Expected Rate of Return = R1P1 + R2P2 + R3P3 ...

= (45% x 30%) + (25% x 9%) + (30% x 2%)

= 13.5% + 2.25% + 0.6%

= 16.35 %