You are considering buying a share of stock in a firm that has the following two possible payoffs with the corresponding probability of occurring. The stock has a purchase price of $15.00
You forecast that there is a 30% chance that the stock will sell for $30.00 at the end of one year. The alternative expectation is that there is a 70% chance that the stock will sell for $10.00 at the end of one year. What is the expected percentage return on this stock, and what is the return variance?
A) 6.67%, 9.17%
B) 1.00%, 93.50%
C) 6.67%, 37.33%
D) 84.00%, $9.67
Answer: C
Explanation: C) Expected payoff = Σ Expected payoffi × probabilityi = .30 ∗ $30.00 + .70 ∗ $10 = $16.00.
E(r) = = = 6.67%
Variance = (0.30)(1.00 - 0.0667)2 + (0.70)(-0.333 - 0.0677)2 = 0.377, or 37.33%.
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