What is Expected Return?
The Expected Return measures the anticipated return on an investment or portfolio of securities, expressed in the form of a percentage.
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How to Calculate the Expected Return?
By measuring the expected return on a probability-weighted basis, investors can estimate the return from an investment or portfolio of securities.
In corporate finance, the expected return of a portfolio signifies the anticipated yield that could potentially be generated over a pre-defined time frame.
Understanding the expected risk-adjusted return on a portfolio contributes to more informed investment decisions, where the risk-return profile of the investment can be structured to more closely align with the investor’s risk appetite and target yield.
The expected return is a critical component to constructing a portfolio that can generate the target return while mitigating risk to a manageable level.
The expected return is calculated by multiplying the probability of each possible return scenario by its corresponding value and then adding up the products.
The expected return metric – often denoted as “E(R)” – considers the potential return on an individual security or portfolio and the likelihood of each outcome.
However, the implied return is not merely a simple average but rather a range of potential outcomes, which facilitates a more comprehensive assessment of the risk-reward profile of the investment portfolio.
The incorporation of probability weights in analyzing potential returns improves the depth of the decision-making process for investors, especially with regard to understanding the potential upside and downside of an investment portfolio, akin to performing scenario analysis.