You are considering buying a share of stock in a firm that has the fol

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 $50.00. You forecast that there is a 40% chance that the stock will sell for $70.00 at the end of one year. The alternative expectation is that there is a 60% chance that the stock will sell for $30.00 at the end of one year. What is the expected percentage return on this stock, and what is the return variance?
A) -8.00%, 15.36%
B) 4.00%, 30.72%
C) 8.00%, 15.36%
D) -4.00%, -30.72%

ANSWER

Answer: A
Explanation: A) Expected payoff = Σ Expected payoffi × probabilityi = .40 ∗ $70.00 + .60 ∗ $30 = $46.00.
E(r) = = = -8.00%
Variance = (0.40)(0.40 – (-.08))2 + (0.60)(-0.40 – (-0.08))2 = 0.1536, or 15.36%.