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Finance: What is an Expected Return? 8 Views

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Description:

Reading the tarot cards. Sifting the tea leaves. Asking the crystal ball. Trying to predict the future performance of an investment is something that keeps hundreds of thousands of analysts around the world gainfully employed. For those who look to the past to attempt to forecast what is yet to come, one might look at the past five years’ returns and calculate an average. This would then be applied to a portfolio and weighted accordingly to allocation size, and calculated again for the overall portfolio. Again, the expected return is akin to an educated guess and obviously could not take into consideration deux ex machina events, such as natural disasters, war, a market crash, or other calamities.

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Transcript

00:00
Finance, a la shmoop. what is expected return? Okay we've been experimenting for
00:08
months on libertarians with cancer in a gwangju prison. Our drug is gonna do one [ man swallows pill]
00:14
of three things. A. it may make the prisoners glow in the dark. Not all that
00:19
useful as a drug discovery but it would allow investors to sell the company to [man's face glows]
00:24
cirque de soleil who would be thrilled to cut down on bodypaint expenses. All

00:29
right well if event A happens investors will get at least a 20% return on our [circus performers shown]
00:34
money odds of the the glow must go on happening ? 35% . okay moving on. Event B, our
00:41
drug may well just kill them - yeah that's a bunch of libertarians in a gwangju
00:46
prison. Who's gonna notice, right? in which case investors lose all of their money [money on fire]
00:50
and the glow must go on just folds up tent, and goes away. The return there
00:55
would be zero. Odds of this happening? Well, 60% yeah
00:59
six out of ten. Probably gonna die. okay event C the drug cures cancer! If that [written explanation shown]
01:03
happens while investors get a thousand percent return on their money .Save the
01:08
world and in general improve their tinder match ratio by like a zillion.
01:13
Odds of this happening, well just 5% but hey it's worth a shot right?
01:18
So our adjusted probability chart looks like- this - see we got return and odds and [chart shown]
01:24
expect the case 2035, 7 yeah there we go.
01:27
So what is all this telling us ? Well that the overall expected return - yeah you
01:32
knew we'd get there eventually - is a 57% return on our investment. Great return!
01:39
bottom line do it the chance of curing cancer would be well worth the risk. And [people dance]
01:44
if not well at least there would be fewer bicycling accidents.
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