The Table below presents returns across three states of nature for two assets: Risky and Safe. The expected return on Safe is 8.4%. Which asset has a higher expected return? $$\begin{array} { | c | c | c | c | }
\hline \text { State of Nature } & \text { Probability } & \begin{array} { c }
\text { Return to Risky } \
\text { Investment }
\end{array} & \begin{array} { c }
\text { Return to Safe } \
\text { Investment }
\end{array} \
\hline \text { Recession } & 0.2 & - 5 \% & 14 \% \
\hline \text { Normal } & 0.6 & 15 \% & 8 \% \
\hline \text { Boom } & 0.2 & 25 \% & 4 \% \
\hline
\end{array}$$
A)Risky
B)Safe
C)Both have the same expected return

Question

The Table below presents returns across three states of nature for two assets: Risky and Safe. The expected return on Safe is 8.4%. Which asset has a higher expected return? $$\begin{array} { | c | c | c | c | } 
\hline \text { State of Nature } & \text { Probability } & \begin{array} { c } 
\text { Return to Risky } \
\text { Investment }
\end{array} & \begin{array} { c } 
\text { Return to Safe } \
\text { Investment }
\end{array} \
\hline \text { Recession } & 0.2 & - 5 \% & 14 \% \
\hline \text { Normal } & 0.6 & 15 \% & 8 \% \
\hline \text { Boom } & 0.2 & 25 \% & 4 \% \
\hline
\end{array}$$
A)Risky
B)Safe
C)Both have the same expected return

Quizplus · Accepted Answer

The expected return for the Risky asset is calculated as: (0.2 * -5%) + (0.6 * 15%) + (0.2 * 25%) = 13%. Since 13% is greater than the 8.4% expected return of the Safe asset, the Risky asset has a higher expected return.

The Table Below Presents Returns Across Three States of Nature