Question

Use the following scenario analysis for stocks X and Y to answer CFA Questions

Question: What are the expected returns for stocks X and Y?

Short answer

The correct answer is:

E(r_X) = 20%

E(r_Y) = 10%

Step-by-step solution

Given information

Probability (scenario- Bear Market) = 0.2

Probability (scenario-Normal Market) = 0.5 and

Probability (scenario- Bull Market) = 0.3

Return for Stock X (all 3 scenarios) = --20%, 18% and 50%

Return for Stock Y (all 3 scenarios) = --15%, 20% and 10%

Calculation of expected return for stocks X and Y

Expected return =[Probability (Scenario) x Return in Scenario]

Hence,

E(r_X) = [0.2 x (–20%)] + [0.5 x 18%] + [0.3 x 50%)] = 20%

E(r_Y) = [0.2 x (–15%)] + [0.5 x 20%] + [0.3 x 10%)] = 10%