The expected return is the profit or loss that an investor anticipates on a known historical rate of return investment (RoR). It is calculated by multiplying potential outcomes by their likelihood of occurrence and then adding the results.
Calculating expected returns is an important part of both business operations and financial theory, as seen in the well-known models of modern portfolio theory (MPT) and the Black-Scholes options pricing model.
For example, if an investment has a 50% chance of increasing by 20% and a 50% chance of decreasing by 10%, the expected return is 5% = (50% x 20% + 50% x -10% = 5%).
The expected return is a tool used to determine whether an investment has a positive or negative average net outcome. The sum is calculated as the expected value (EV) of an investment given its potential returns in different scenarios, as illustrated by the following formula:
Expected Return = Σ (Returni x Probabilityi)
where "i" indicates each known return and its respective probability in the series
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