As part of an investment team at a large Canadian investment company, you are analyzing the returns
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Question:
As part of an investment team at a large Canadian investment company, you are analyzing the returns of two stocks: TD bank and Sobey. You consider five possible scenarios for the stocks’ returns depending on how good the economy will be over the coming year. TD bank has a 0.9 correlation with the market portfolio. Sobey has a -0.5 correlation with the market portfolio. The market portfolio has a standard deviation of 10%. The risk free rate is equal to 4%.
Economy scenario | Probability | Return on TD bank stock | Return on Sobey stock |
Boom | 0.3 | 30% | 8% |
Above average | 0.2 | 20% | 8% |
Average | 0.2 | 10% | 10% |
Below average | 0.2 | 0% | 12% |
Recession | 0.1 | -20% | 15% |
If TD bank stock is correctly priced today, then what is the expected return on the market portfolio?
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