Final answer:
To calculate the expected return on a stock, multiply each possible return by its probability and sum these values. The concept of expected value in finance is used for this purpose, providing a weighted average of all possible returns.
Step-by-step explanation:
The question at hand is concerned with calculating the expected return on a stock investment in different economic conditions. To determine the expected return, one needs to understand the concept of expected value, a fundamental idea in finance that signifies the average return an investor might expect over time if the investment were repeated multiple times. Expected value is calculated by multiplying each possible outcome by the probability of that outcome occurring and then summing all these values.
Let me provide an example to help clarify this concept. Imagine an investment with three possible returns: a 1% loss (with a 35% probability), a 0% change (with a 60% probability), and a 1000% gain (with a 5% probability). The expected return would be calculated by adding the product of each outcome and its respective probability (1% * 35% + 0% * 60% + 1000% * 5%). This calculation results in an expected return of 4.95%, which would be choice b if it were one of the options provided.
In a real-world scenario, you would apply this formula using the precise values provided for the particular stock investment in question. This would help you understand what return you might typically expect, taking into account all the potential economic conditions presented.