Consider the following states of outcomes, probabilities, and expected returns on only stocks three stocks in your portfolio; X, Y, and Z. State Probability X Y Z Boom 0.1 16% 10% 22% Semi-Boom 0.15 14% 8% 18% Normal 0.55 10% 6% 14% Mild-Recession ?? 5% 4% -10% Full-Recession 0.05 -3% 2% -12% a. What is the expected return of the portfolio if $25,000 is invested in X, $35,000 in Y, and $30,000 invested in stock Z? b. What are the standard deviations of stocks X, Y, and Z?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Consider the following states of outcomes, probabilities, and expected returns on only stocks three stocks in your portfolio; X, Y, and Z.
|
State |
Probability |
X |
Y |
Z |
|
Boom |
0.1 |
16% |
10% |
22% |
|
Semi-Boom |
0.15 |
14% |
8% |
18% |
|
Normal |
0.55 |
10% |
6% |
14% |
|
Mild-Recession |
?? |
5% |
4% |
-10% |
|
Full-Recession |
0.05 |
-3% |
2% |
-12% |
a. What is the expected return of the portfolio if $25,000 is invested in X, $35,000 in Y, and $30,000 invested in stock Z?
b. What are the standard deviations of stocks X, Y, and Z?
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