Skip to content

NISM Certifications · NISM-Series-XV: Research Analyst · Fundamentals of Risk and Return

A stock has an expected return of 12% under a boom scenario with probability 0.4, 8% under a normal scenario with probability 0.4, and 2% under a recession scenario with probability 0.2. What is the probability-weighted expected return?

The expected return is 8.4%. Multiply each scenario return by its probability and add them: 4.8% plus 3.2% plus 0.4%. A simple average of the three returns would wrongly ignore the differing probabilities of the scenarios.

  1. A8.4%Correct
  2. B7.3%
  3. C9.0%
  4. D8.0%

Explanation

Expected return = 0.4×12 + 0.4×8 + 0.2×2 = 4.8 + 3.2 + 0.4 = 8.4%. The simple average of the three returns gives 7.33%, which ignores the probabilities. Checking: 8.4 lies between 2 and 12 and nearer to the heavier-weighted 8 and 12.

Did you get it right without looking?

One question tells you little. A timed set on Fundamentals of Risk and Return shows your real accuracy, how long you take and where you lose marks.

Practise Fundamentals of Risk and ReturnFree diagnostic mock

More Fundamentals of Risk and Return questions