Calculating the Expected Life of a Stock – Common Practice in Exercises

### Calculating the Expected Value of a Stock In most exercises, the student is asked to calculate the expected value of a certain stock, based on the following information: – **Reference to various scenarios in a certain time period and the probability of their realization.**
– The scenarios usually refer to 2-3 economic situations, such as:
– Economic recession
– Economic stability
– Economic prosperity
– Scenarios are also commonly called: **States of Nature.**
– Each scenario (state of nature) is accompanied by the probability of its realization and the yield data in each scenario. #### The calculation: 1. In each scenario, multiply the yield in the scenario by the probability of the scenario occurring.
2. The resulting result is called: **Scenario contribution to expectancy**.
3. Sum the **contribution to expectancy** in all scenarios and the result is **stock expectancy**. #### Example In columns 1-3 the information is given. In column 4 the calculation is performed. | Scenarios | Scenario probability | Scenario return | Scenario contribution to expectancy (3)*(2) |
|———-|—————–|—————-|
| Recession | 20% (=0.2) | -0.02 | -0.004 = -0.4% |
| Stability | 50% (=0.5) | 0.06 | 0.03 = 3% |
| Prosperity | 30% (=0.3) | 0.10 | 0.03 = 3% |
| Total | 100% | | 0.056 = 5.6% Stock Expectation |