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CMA Intermediate · Financial Management and Business Data Analytics · Risk and Return

The expected returns on Asset X in three equally likely economic states (boom, normal, recession) are 30%, 18% and 6% respectively. What is the expected return of Asset X?

The expected return is 18%. With equal probabilities of one-third each, the expected return is the probability-weighted average of 30%, 18% and 6%, which sums to 54% and divides by three to give 18%.

  1. A15%
  2. B20%
  3. C18%Correct
  4. D24%

Explanation

Expected return = (30 + 18 + 6)/3 = 54/3 = 18%. Using only the boom and normal states gives 24%. Using only the normal state or the wrong midpoint gives other values, which do not weight all three equally.

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