An investment ﬁrm is considering a portfolio with equal weighting in a cyclical stock and a countercyclical stock. It is expected that there will be three economic states; Good, Average and
Bad, each with equal probabilities of occurrence. The cyclical stock is expected to have returns of
12%, 5% and 1% in Good, Average and Bad economies respectively. The countercyclical stock is
Expected to have returns of -8%, 2% and 14% in Good, Average and Bad economies respectively.
Given this information, calculate portfolio expected return.
A) 2.32%
B) 3.32%
C) 4.32%
D) 5.32%
E) 6.32%

Question

Quizplus · Accepted Answer

The portfolio expected return is the weighted average of the expected returns of the two stocks. The weights are equal, so the portfolio expected return is the average of the two expected returns. The expected return of the cyclical stock is (12% + 5% + 1%) / 3 = 6%. The expected return of the countercyclical stock is (-8% + 2% + 14%) / 3 = 3%. Therefore, the portfolio expected return is (6% + 3%) / 2 = 4.5%.

An Investment ﬁRm Is Considering a Portfolio with Equal Weighting