Question

You are considering buying stock A. If the economy grows rapidly, you may earn 30 percent on the investment, while a declining economy could result in a 20 percent loss. Slow economic growth may generate a return of 6 percent. If the probability is 15 percent for rapid growth, 20 percent for a declining economy, and 65 percent for slow growth, what is the expected return on this investment?

Answer 1

Probability of Rapid Growth = 15%
Return during Rapid Growth = 30%
Probability of Declining Economy = 20%
Return during Declining Economy = -20%
Probability of Slow Growth = 65%
Return during Slow Growth = 6%

Expected Return = Probability of Rapid Growth * Return during Rapid Growth + Probability of Declining Economy * Return during Declining Economy + Probability of Slow Growth * Return during Slow Growth
Expected Return = 15% * 30% + 20% * (-20%) + 65% * 6%
Expected Return = 4.40%

So, the expected return on this investment is 4.40%