Chapter 11, Problem 22QAP

a

Summary Introduction

Adequate information:

Probability in Boom $\left({\text{P}}_{\text{Bo}}\right)$ = 0.20

Probability in Normal $\left({\text{P}}_{\text{No}}\right)$ = 0.55

Probability in Bust $\left({\text{P}}_{\text{Bu}}\right)$ = 0.20

Expected return for Stock A in Boom $\left(\text{R}{\left(\text{A}\right)}_{\text{Bo}}\right)$ = 0.25

Expected return for Stock A in Normal $\left(\text{R}{\left(\text{A}\right)}_{\text{No}}\right)$ = 0.18

Expected return for Stock A in Bust $\left(\text{R}{\left(\text{A}\right)}_{\text{Bu}}\right)$ = 0.03

Expected return for Stock B in Boom $\left(\text{R}{\left(\text{B}\right)}_{\text{Bo}}\right)$ = 0.35

Expected return for Stock B in Normal $\left(\text{R}{\left(\text{B}\right)}_{\text{No}}\right)$ = 0.13

Expected return for Stock B in Bust $\left(\text{R}{\left(\text{B}\right)}_{\text{Bu}}\right)$ = -0.18

Expected return for Stock C in Boom $\left(\text{R}{\left(\text{C}\right)}_{\text{Bo}}\right)$ = 0.40

Expected return for Stock C in Normal $\left(\text{R}{\left(\text{C}\right)}_{\text{No}}\right)$ = 0.03

Expected return for Stock C in Bust $\left(\text{R}{\left(\text{C}\right)}_{\text{Bu}}\right)$ = -0.45

Weight of Stock A $\left({\text{W}}_{\text{A}}\right)$ = 0.40

Weight of Stock B $\left({\text{W}}_{\text{B}}\right)$ = 0.40

Weight of Stock C $\left({\text{W}}_{\text{C}}\right)$ = 0.20

To compute: Portfolio expected return, variance, and standard deviation

Introduction: Expected return on the portfolio refers to the return expected on the investment portfolio. Portfolio variance is a statistical metric used to measure the dispersion of returns. Standard deviation refers to the measurement of the dispersion of actual returns from average returns.

b

Summary Introduction

Adequate information:

Expected T-bill rate $\left({\text{T}}_{\text{r}}\right)$ = 0.038

To compute: Expected risk premium

Introduction: Risk premium refers to the return in addition to the risk-free rate for bearing extra risk by the investor.

c

Summary Introduction

Adequate information:

Expected inflation rate $\left({\text{I}}_{\text{r}}\right)$ = 0.035

To compute: Approximate and exact expected real returns and risk premiums

Introduction: Real rate of return refers to the actual returns on the investment. Risk premium refers to the return in addition to the risk-free rate for bearing extra risk by the investor.