Question

Explain why expected return is considered forward-looking. What challenges arise in using expected return?

Answer 1

Expected retturn is forward looking because it is the rate of return that an investor expects to earn in the future for the market risk he is taking today by investing. The expected return may or may not be achieved in the future. The expected return is calculated using the past data and current conditions. this return is what is expepected in the future.

The challenge is that investors cannot predict exactly what the future might turn out to be. The expected retrun is sensitive to the assumptions that have been made. A small change in assumptions may lead to an unfavourable outcome for an investor.