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Consider an economy with two types of firms: S and U. The S firms always move together, but U firms move independently of each other. For both types of firms there is a 70% probability that the firm will have a 20% return and a 30% probability that the firm will have a -30% return.
-What is the expected return for an individual firm?
A)14%
B)5%
C)3%
D)-5%

Question

Quizplus · Accepted Answer

To calculate the expected return, we take the weighted average of the possible returns. 
For S firms, there is only one possible return of 20%. 
For U firms, there is a 70% chance of a 20% return and a 30% chance of a -30% return. 
So the expected return for an individual firm is: 
(0.7 x 0.2) + (0.3 x -0.3) = 0.14 - 0.09 = 0.05 or 5%. 
Therefore, the best choice is B, which is the expected return for an individual firm.

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