Guided Response: Review several of your classmates’ posts. Respond to at least two classmates by sharing whether you agree or disagree with their view of the use of the company’s capital. Explain why.
The question discussed in week 4 of Bus 401 Principles of Finance was “Evaluate the concept of expected return and how it affects investment decisions.” In order to provide a comprehensive answer to this topic, two different sets of answers are explored.
First, we will look at the expected return in purely mathematical terms. The expected return represents the average outcome of all possible returns for an investment. The expected return is calculated by adding together all possible combinations and the associated probabilities. After that, divide the result by the number of scenarios or combinations. The expected return can be used to evaluate investments and help determine whether there is an acceptable risk/reward ratio. It may be worthwhile to pursue an investment if a greater expected return is possible with lower risk.
Second, we will look at the expected return from an behavioural standpoint. Most people have different expectations about the return they’ll receive when making an investment. It could be that they expect to receive a substantial windfall, or gain more than their expectations. Or it might simply be that they want to earn a specific rate of returns. These expectations may lead investors to take higher risk to try to earn higher returns. To be successful in investing, it is important to understand the psychology behind expected returns.
The expected return is an essential concept when you invest. It can be helpful to understand how it is calculated to help you decide the risk that you will take to reach your goals. Understanding how investors see expected returns can also help you to shape strategies and make decisions.