This is one of the probability qns in qbank Tina O’Fahey, CFA, believes a stock’s price in the next quarter depends on two factors: the direction of the overall market and whether the company’s next earnings report is good or poor. The possible outcomes and some probabilities are illustrated in the tree diagram shown below: Actually there is a tree diagram to illustrate the probability of the stock value. Since i’m not able to draw here , i will post it in text as show below: Prob of market increase = 55% If market increase,: prob of good earnings will be 60% and price will be $70 prob of poorearnings will be 40% and price will be $65 Prob of market decrease = 45% If market decrease: prob of good earnings will be 40% and price will be $60 prob of poorearnings will be 60% and price will be $55 The expected value of the stock if the market decreases is closest to: A) $57.00. B) $62.50. C) $26.00. The correct answer was A) $57.00. The expected value if the overall market decreases is 0.4($60) + (1 – 0.4)($55) = $57 This is my understanding and calculation as stated below: My calculation is (0.45*0.4*$60) + (0.45*0.6*$55) What i dun understand is since the question asks for expected value of stock if market decrease and the prob of market decrease is 45%, why dun it include the 45% into the calculation but use this way 0.4($60) + (0.6)($55) = $57? thanks
they told you market decreased. so that is a 100% probability, not 45%.
oh i see. thanks thanks