You recently purchased a stock that is expected to earn 16% in a booming economy, 12% in a normal economy, and lose 8% in a recessionary economy. There is a 20% probability of a boom, a
70% chance of a normal economy, and a 10% chance of a recession. What is your expected rate of
Return on this stock?
A) 6.00%
B) 6.67%
C) 8.60%
D) 10.80%
E) 12.40%

Question

Quizplus · Accepted Answer

To calculate the expected rate of return, we use the formula: 
Expected Return = (Probability of Boom x Return in a Boom) + (Probability of Normal Economy x Return in a Normal Economy) + (Probability of Recession x Return in a Recession)

Expected Return = (0.20 x 16%) + (0.70 x 12%) + (0.10 x -8%)
Expected Return = 3.2% + 8.4% - 0.8%
Expected Return = 10.8%
Therefore, the expected rate of return on this stock is 10.8%, which is option D.

You Recently Purchased a Stock That Is Expected to Earn