Concept explainers
(Expected return and standard deviation) What is the expected return and standard devia- tion of the return for the next year on a stock that is selling for $30 now and has probabil- ities of 0.2, 0.6, and 0.2 of selling one year from now at $24, $33, and $39, respectively? Assume that no dividends will be paid on the stock during the next year and ignore taxes?
EXPECTED RETURN
The expected return of an investment is the expected value of probable return investment can generate. It is calculated by multiplying each expected future return with the probability of occurring such return.
Expected return =
where,
R = Expected return
P = probability of return
n = number of years
STANDARD DEVIATION
Standard deviation is the measure of volatility in expected future stock prices. It is a smile mathematical tool to measure the difference of returns with respect to mean.
Formula,
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