Expected

Lesson

Expected returns are the anticipated returns on an investment based on historical data, probability distributions, and other factors.

Practice Question #1

Which of the following factors is NOT typically considered when calculating expected returns for an isolated investment?

A) Historical returns

B) Probability distributions

C) Correlation with other assets

D) Dividend yield

Select an option above to see an explanation here.

A) Historical returns estimate future returns based on past performance. B) Probability distributions help determine the likelihood of different outcomes for an investment. C) Correlation with other assets is essential for understanding the relationship between investments and diversification but does not impact the expected return for an isolated investment. D) Dividend yield measures income an investment generates and may impact expected returns.

Terms

Expected Return:: The anticipated return on an investment based on historical data, probability distributions, and other factors.
Probability Distribution:: A statistical function that describes the likelihood of different outcomes for a random variable.

Practice Question #2

What is the primary purpose of diversification in a portfolio?

A) To increase expected returns

B) To reduce risk

C) To maximize dividend income

D) To minimize taxes

Select an option above to see an explanation here.

A) Diversification may or may not increase expected returns, depending on the assets chosen. B) The primary purpose of diversification is to reduce risk by spreading investments across different assets or asset classes. C) Diversification is not specifically focused on maximizing dividend income. D) Minimizing taxes is a separate consideration from diversification.

Do Not Confuse With

Realized Return:: The actual return on an investment, as opposed to the expected return.

Practice Question #3

Which of the following measures the strength and direction of the relationship between two variables?

A) Standard deviation

B) Variance

C) Covariance

D) Correlation

Select an option above to see an explanation here.

A) Standard deviation measures the dispersion of data points, often used to quantify investment risk. B) Variance is the square of the standard deviation, representing the average of the squared differences from the mean. C) Covariance measures how two variables change together, often used to assess the relationship between the returns of two investments. D) Correlation is a standardized measure of the strength and direction of the relationship between two variables, ranging from -1 (perfect negative correlation) to 1 (perfect positive correlation).

Historical Example

In the 1990s, many investors had high expected returns for technology stocks based on their historical performance and the rapid growth of the internet. However, the dot-com bubble burst in the early 2000s, leading to significant losses for many investors who had not adequately diversified their portfolios.