ER) = 26%

percent return in 80 percent of the years and a 10 percent return in 20 percent of the years. To calculate the expected return, we again just multiply the possibilities by the probabilities and add up the results:

Table 13.3 summarizes the calculations for both stocks. Notice that the expected return on L is -2 percent.

The risk premium for Stock U is 26% - 10% = 16% in this case. The risk premium for Stock L is negative: -2% - 10% = -12%. This is a little odd, but, for reasons we discuss later, it is not impossible.

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