How Is Expected Return Calculated

Expected Return Formula:

\[ \text{Expected Return} = \sum (Probability_i \times Return_i) \]

Probability 1:

(0-1)

Return 1:

Probability 2:

(0-1)

Return 2:

Probability 3:

(0-1)

Return 3:

Expected Return:

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1. What Is Expected Return?

Expected Return is a fundamental concept in finance and investment that calculates the average of all possible returns weighted by their respective probabilities. It represents the mean value of the probability distribution of possible returns.

2. How Does The Calculator Work?

The calculator uses the expected return formula:

\[ \text{Expected Return} = \sum (Probability_i \times Return_i) \]

Where:

\( Probability_i \) — The likelihood of each outcome (must sum to 1)
\( Return_i \) — The return associated with each outcome (in percentage or currency units)
\( \sum \) — Summation across all possible scenarios

Explanation: This calculation averages all possible returns, weighting each by its probability of occurrence, providing a single measure of central tendency for investment outcomes.

3. Importance Of Expected Return Calculation

Details: Expected return is crucial for investment decision-making, portfolio optimization, risk assessment, and comparing different investment opportunities. It helps investors understand the potential average outcome of their investments.

4. Using The Calculator

Tips: Enter probabilities as decimal values between 0 and 1 that must sum exactly to 1. Enter returns as percentages. The calculator will compute the weighted average expected return.

5. Frequently Asked Questions (FAQ)

Q1: Why must probabilities sum to 1?
A: Probabilities must sum to 1 to ensure all possible outcomes are accounted for, making the probability distribution complete and valid.

Q2: What's the difference between expected return and actual return?
A: Expected return is a statistical prediction based on probabilities, while actual return is the realized outcome that may differ due to random factors.

Q3: Can I use this for multiple investment scenarios?
A: Yes, you can extend the calculation to any number of scenarios by adding more probability-return pairs, ensuring probabilities always sum to 1.

Q4: How accurate is expected return in predicting future returns?
A: It provides a mathematical expectation but doesn't guarantee future results. Actual returns may vary due to unforeseen market conditions and risks.

Q5: What are common applications of expected return?
A: Portfolio management, capital budgeting, risk analysis, investment comparison, and financial planning across various asset classes.