Consider the following information:

Probability of State Rate of Return if State Occurs

Economy of Economy Stock A Stock B

Recession. 20.010 -.35

Normal. 55.090.25

Boom. 25.240.48

a. Calculate the expected return for the two stocks.'

11.15%

Explanation:

The formula to compute the expected rate of return is shown below:

Expected rate of return = (Recession probability * Possible Returns) + (Normal Probability * Possible Returns) + (Boom Probability * Possible Returns 3)

= (0.20 * 0.010) + (0.55 * 0.090) + (0.25 * 0.240)

= 0.002 + 0.0495 + 0.06

= 11.15%

Simply we multiply the probability with its return so that accurate rate could come.