Midwest Fastener Supply stock is expected to return 16 percent in a booming economy, 12 percent in a normal economy, and −3 percent in a recession. The probabilities of an economic boom, normal state, or recession are 12 percent, 80 percent, and 8 percent, respectively. What is the expected rate of return on this stock?

11.28%

Explanation:

Midwest fastener stock is expected to have a 16% booming economy

12% normal economy

-3% recession economy

The probability of an economic boom is 12%

The probability of a normal state is 80%

The probability of a recession is 8%

Therefore, the expected rate of return can be calculated as follows

= (return in booming economy×probability of boom economy)+(return in normal economy × probability of normal economy)+(return in recession economy×probability of recession economy)

= (16%+12%)+(12%+80%)+(-3%+8%)

= 192%+960%+(-24%)

= 192%+960%-24%

= 1,128%/100

= 11.28%

Hence the expected rate of return on the stock is 11.28%

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