Answered: The expected rate of return on Happy…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter8: Analysis Of Risk And Return

Section: Chapter Questions

Problem 13QTD

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2. Statistical measures of stand-alone risk

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:

David owns a two-stock portfolio that invests in Happy Dog Soap Company (HDS) and Black Sheep Broadcasting (BSB). Three-quarters of David’s portfolio value consists of HDS’s shares, and the balance consists of BSB’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	Happy Dog Soap	Black Sheep Broadcasting
Strong	0.50	42.5%	59.5%
Normal	0.25	25.5%	34%
Weak	0.25	-34%	-42.5%

Calculate expected returns for the individual stocks in David’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 Happy Dog Soap’s stock over the next year is ________.
•	The expected rate of return on Black Sheep Broadcasting’s stock over the next year is _____.
•	The expected rate of return on David’s portfolio over the next year is _______.

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