Suppose you own a stock that you believe will produce a return of 13% in a good economy and 4% in a poor economy. Given the probabilities of each state of the economy occurring, you think that your stock will earn 8.0% next year. Which one of the following terms does this 8% describe?

A) Arithmetic return

B) Expected return

C) Historical return

D) Required return

E) Geometric return

The correct answer is letter "B": Expected return.

Explanation:

Expected return is the return an investor expects from an investment given the investment's historical return or probable rates of return under different scenarios. To determine expected returns based on historical data, an investor simply calculates an average of the investment's historical return percentages and then, uses that average as the expected return for the next investment period.

In the example, the expected return would be:

Expected return = (return in a good economy + return in a poor economy) / 2

Expected return = (13% + 4%) / 2

Expected return = 8,5%