CFA Level IQuantitative MethodsEasy
A financial analyst is evaluating two investment opportunities, Fund A and Fund B, over a one-year period. Fund A has a 40% chance of returning 15% and a 60% chance of returning 5%. Fund B has a 70% chance of returning 12% and a 30% chance of returning 4%. Which fund offers the higher expected return and by how much?
- AFund B by 1.0%
- BFund B by 0.2%
- CFund A by 1.8%
- DFund A by 0.6%
Show answer & explanationAnswer & explanation
Correct answer: B. Fund B by 0.2%
The expected return is calculated by summing the products of each possible outcome and its probability. Comparing the expected returns for Fund A and Fund B reveals the difference.
Why the other options are wrong
- A. This calculation is incorrect for both funds or the difference.
- C. This calculation is incorrect for both funds or the difference.
- D. This calculation is incorrect for both funds or the difference.
Expected Value
The expected value of a random variable is the weighted average of all possible values, where the weights are the probabilities of each value occurring.
- Represents the average outcome if an experiment is repeated many times.
- Calculated as Σ(x_i * P(x_i)).
- Can be used for discrete or continuous random variables.
Memory trick: Probability's Product Sums to Expectation's Outcome.