Statistical measures of standalone riskRemember, the expected value of a probability distribution is a statistical measure of the average (mean) value expected to occur during all possible circumstances. To compute an asset’s expected return under a range of possible circumstances (or states of nature), multiply the anticipated return expected to result during each state of nature by its probability of occurrence.Consider the following case:Tyler owns a two-stock portfolio that invests in Falcon Freight Company (FF) and Pheasant Pharmaceuticals (PP). Three-quarters of Tyler’s portfolio value consists of FF’s shares, and the balance consists of PP’s shares.Each stock’s expected return for the next year will depend on forecasted market conditions. The expected returns from the stocks in different market conditions are detailed in the following table:Market ConditionProbability of OccurrenceFalcon FreightPheasant PharmaceuticalsStrong0.5012.5%17.5%Normal0.257.5%10%Weak0.25-10%-12.5% Calculate expected returns for the individual stocks in Tyler’s portfolio as well as the expected rate of return of the entire portfolio over the three possible market conditions next year.•The expected rate of return on Falcon Freight’s stock over the next year is .•The expected rate of return on Pheasant Pharmaceuticals’s stock over the next year is .•The expected rate of return on Tyler’s portfolio over the next year is . The expected returns for Tyler’s portfolio were calculated based on three possible conditions in the market. Such conditions will vary from time to time, and for each condition there will be a specific outcome. These probabilities and outcomes can be represented in the form of a continuous probability distribution graph.

Expected return can be defined as the weighted average of the distribution of probable returns of…

Answered: Tyler owns a two-stock portfolio that…

Corporate Fin Focused Approach

5th Edition

ISBN:9781285660516

Author:EHRHARDT

Publisher:EHRHARDT

Chapter6: Risk And Return

Section: Chapter Questions

Problem 1Q

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Statistical measures of standalone risk

Remember, the expected value of a probability distribution is a statistical measure of the average (mean) value expected to occur during all possible circumstances. To compute an asset’s expected return under a range of possible circumstances (or states of nature), multiply the anticipated return expected to result during each state of nature by its probability of occurrence.

Consider the following case:

Tyler owns a two-stock portfolio that invests in Falcon Freight Company (FF) and Pheasant Pharmaceuticals (PP). Three-quarters of Tyler’s portfolio value consists of FF’s shares, and the balance consists of PP’s shares.

Each stock’s expected return for the next year will depend on forecasted market conditions. The expected returns from the stocks in different market conditions are detailed in the following table:

Market Condition	Probability of Occurrence	Falcon Freight	Pheasant Pharmaceuticals
Strong	0.50	12.5%	17.5%
Normal	0.25	7.5%	10%
Weak	0.25	-10%	-12.5%

Calculate expected returns for the individual stocks in Tyler’s portfolio as well as the expected rate of return of the entire portfolio over the three possible market conditions next year.

•	The expected rate of return on Falcon Freight’s stock over the next year is .
•	The expected rate of return on Pheasant Pharmaceuticals’s stock over the next year is .
•	The expected rate of return on Tyler’s portfolio over the next year is .

The expected returns for Tyler’s portfolio were calculated based on three possible conditions in the market. Such conditions will vary from time to time, and for each condition there will be a specific outcome. These probabilities and outcomes can be represented in the form of a continuous probability distribution graph.

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