The expected return on a security is currently based on a 22 percent chance of a 15 percent return given an economic boom and a 78 percent chance of a 12 percent return given a normal economy. Which of the following changes will decrease the expected return on this security? I. an increase in the probability of an economic boom
II) a decrease in the rate of return given a normal economy
III) an increase in the probability of a normal economy
IV) an increase in the rate of return given an economic boom
A) I and II only
B) I and IV only
C) II and III only
D) I, III, and IV only
E) I, II, III, and IV

Question

Quizplus · Accepted Answer

The expected return on a security is calculated by multiplying the probability of each possible return by its associated return and summing them up. Therefore, an increase in the probability of an economic boom (I) or an increase in the rate of return given an economic boom (IV) will increase the overall expected return. On the other hand, a decrease in the rate of return given a normal economy (II) or an increase in the probability of a normal economy (III) will decrease the expected return. Therefore, only option C includes factors that could potentially decrease the expected return on this security.

The Expected Return on a Security Is Currently Based on a 22