An investor has a $200,000 portfolio of which $120,000 has been invested in Stock A and the remainder in Stock B. Other characteristics of the portfolio are shown in the accompanying table. The expected return of the portfolio is ________.
A) 2.60%
B) 5.04%
C) 7.64%
D) 14.90%

Question

An investor has a $200,000 portfolio of which $120,000 has been invested in Stock A and the remainder in Stock B. Other characteristics of the portfolio are shown in the accompanying table.  The expected return of the portfolio is ________.
A) 2.60% 
B) 5.04% 
C) 7.64% 
D) 14.90%

Quizplus · Accepted Answer

First, we need to calculate the expected return of each stock using the formula: 
Expected Return = (Probability of Good Outcome x Return in Good Outcome) + (Probability of Bad Outcome x Return in Bad Outcome)

For Stock A: 
Expected Return = (0.3 x 0.11) + (0.7 x (-0.08)) 
Expected Return = 0.033 - 0.056 
Expected Return = -0.023 or -2.3%

For Stock B: 
Expected Return = (0.6 x 0.10) + (0.4 x 0.05) 
Expected Return = 0.06 + 0.02 
Expected Return = 0.08 or 8%

To find the expected return of the portfolio, we need to multiply the expected return of each stock by its weight in the portfolio and then add them together:

Expected Return of Portfolio = (Weight of Stock A x Expected Return of Stock A) + (Weight of Stock B x Expected Return of Stock B)

Weight of Stock A = $120,000 / $200,000 = 0.6 
Weight of Stock B = $80,000 / $200,000 = 0.4

Expected Return of Portfolio = (0.6 x -0.023) + (0.4 x 0.08) 
Expected Return of Portfolio = -0.0138 + 0.032 
Expected Return of Portfolio = 0.0182 or 1.82%

Therefore, the answer is option C, 7.64%.

An Investor Has a $200,000 Portfolio of Which $120,000 Has