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: Ethan owns a two-stock portfolio that invests in Falcon Freight Company (FF) and Pheasant Pharmaceuticals (PP). Three-quarters of Ethan'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 Strong Normal Probability of Occurrence 0.50 0.25 Falcon Freight Pheasant Pharmaceuticals 27.5% 38.5% 16.5% 22% Weak 0.25 -22% -27.5% Calculate expected returns for the individual stocks in Ethan'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 Ethan's portfolio over the next year is
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: Ethan owns a two-stock portfolio that invests in Falcon Freight Company (FF) and Pheasant Pharmaceuticals (PP). Three-quarters of Ethan'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 Strong Normal Probability of Occurrence 0.50 0.25 Falcon Freight Pheasant Pharmaceuticals 27.5% 38.5% 16.5% 22% Weak 0.25 -22% -27.5% Calculate expected returns for the individual stocks in Ethan'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 Ethan's portfolio over the next year is
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text: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:
Ethan owns a two-stock portfolio that invests in Falcon Freight Company (FF) and Pheasant Pharmaceuticals (PP). Three-quarters of
Ethan'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
Strong
Normal
Probability of Occurrence
0.50
0.25
Falcon Freight Pheasant Pharmaceuticals
27.5%
38.5%
16.5%
22%
Weak
0.25
-22%
-27.5%
Calculate expected returns for the individual stocks in Ethan'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 Ethan's portfolio over the next year is
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