Question

Graded Assignment Back to Assignment Due Tuesday 05.21.19 at 10:15 PM Attempts: 7.5 Average: 7.5/10 1. Statistical measures of standalone risk Aa Aa Remember, the expected value of a probability distribution is a statistical measure of the average (mean) value expected to occur during all possible circumstances. To compute an asset's expected return under a range of possible circumstances (or states of nature), multiply the anticipated return expected to result during each state of nature by its probability of occurrence. Consider the following case Dominic owns a two-stock portfolio that invests in Falcon Freight Company (FF) and Pheasant Pharmaceuticals (PP). Three-quarters of Dominic's portfolio value consists of FF's shares, and the balance consists of PP's shares. Each stock's expected return for the next year will depend on forecasted market conditions. The expected returns from the stocks in different market conditions are detailed in the following table Market Condition Probability of Occurrence Falcon Freight Pheasant Pharmaceuticals Strong 50% 15% 21% 1296 Normal 25% 9% -15% Weak 25% -12% Calculate expected returns for the individual stocks in Dominic's portfolio as well as the expected rate of return of the entire portfolio over the three possible market conditions next year . The expected rate of return on Falcon Freight's stock over the next year is .The expected rate of return on Pheasant Pharmaceuticals's stock over the next year is .The expected rate of return on Dominic's portfolio over the next year is

Answer 1

The Expected Rate of return on Falcon Freight’s stock over the next year

Expected Return = Sum of [Returns x Probability]

= [15% x 0.50] + [9% x 0.25] + [-12% x 0.25]

= 7.50% + 2.25% - 3.00%

= 6.75%

The Expected Rate of return on Pheasant Pharmaceuticals stock over the next year

Expected Return = Sum of [Returns x Probability]

= [21% x 0.50] + [12% x 0.25] + [-15% x 0.25]

= 10.50% + 3.00% - 3.75%

= 9.75%

The Expected Rate of return of Dorminic’s Portfolio over the next year

Expected Return = [Expected Rate of return on Falcon Freight’s x Proportion of the Investment in Falcon Freight’s Stock] + [Expected Rate of return on Pheasant Pharmaceuticals stock x Proportion of the Investment in Pheasant Pharmaceuticals stock]

= [6.75% x ¾] + [9.75% x ¼]

= 5.06% + 2.44%

= 7.50%