Question

T. Martell Inc.'s stock has a 50% chance of producing a 30% return, a 25% chance of producing a 9% return, and a 25% chance of producing a -25% return. What is Martell's expected return?

Answer 1

Suppose the given probabilities with expected returns are denoted by p & Er respectively. So,

p1 = 50% = 0.5, p2 = 25% = 0.25, p3 = 25% = 0.25

Er1 = 30%, Er2 = 9%, Er3 = -25%

Now, Expected return is given by the following formula:

Expected return = p1 * Er1 + p2 * Er2 + p3 * Er3

Putting the values in the above equation, we get,

Expected return = (0.5 * 30%) + (0.25 * 9%) + (0.25 * (-25%))

Expected return = 15% + 2.25% + (- 6.25%)

Expected return = 15% + 2.25% + (- 6.25%)

Expected return = 15% + 2.25% - 6.25%

Expected return = 11%