You are considering purchasing stock S. This stock has an expected return of 8% if the economy booms and 3% if the economy goes into a recessionary period. The overall expected rate of return
On this stock will:
A) Be equal to one-half of 8% if there is a 50% chance of an economic boom.
B) Vary inversely with the growth of the economy.
C) Increase as the probability of a recession increases.
D) Be equal to 75% of 8% if there is a 75% chance of a boom economy.
E) Increase as the probability of a boom economy increases.

Question

Quizplus · Accepted Answer

The overall expected rate of return on the stock will increase as the probability of a boom economy increases. This is because the expected return in a boom economy (8%) is higher than the expected return in a recessionary period (3%), and as the probability of a boom economy increases, the weighted average of the expected returns will shift towards the higher return of 8%. Therefore, the overall expected rate of return on the stock will increase.

You Are Considering Purchasing Stock S