2. Calculating expected return: based on the following information calculate the expected return: based on the following information, calculate the expected return:
State of economy Probability of state of economy Portfolio return if state occurs
Recession .25 -.08
Boom .75 .21
Returns and variances: consider the following information:
Rate of return if state occurs
State of economy Probability of state of economy Stock A Stock B Stock C
Boom .35 .07 .15 .33
Bust .65 .13 .03 -.06
a. What is the expected return on an equally weighted portfolio of these three stocks?
b. What is the variance of a portfolio invested 20 percent each in A and B and 60 percent in C?
3. Economies of scale: what does it mean to say that a proposed merger will take advantage of available economies of scale? Suppose Eastern Power Co. and Western Power Co. are located in different time zones. Both of them operate at 60 percent of capacity except for peak periods, when they operate at 100 percent of capacity. The peak periods begin at 9:00 am and 5:00 pm local time and last about 45 minutes. Explain why a merger between Eastern and Western might make sense.
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(.14)w + .105(1-w) = .124
w = .543 = weight in stock x
1-w = .457 = weight in stock y
.543($10,000) = $5,430 in Stock X
.457($10,000) = $4,570 in Stock Y
(Or more precisely, carrying out the decimal places, $5,428.57 in Stock X and $4,571.42 in Stock Y)...