The risk associated with an asset can be assessed more accurately by the use of probability (distribution) than sensitivity analysis. The probability of an event represent the likelihood/percentage chance of its occurrence. For instance, if the expectation is wt a given outcome (return) will occur seven out of ten times, it an be said to have a seventy per cent (0.70) chance of happening; if it is certain to happen, the probability of happening is 100 percent (1) An outcome which has probability of zero will never occur.
Based on the probabilities assigned (probability distribution of) to the rate of return, the expected value of the return can be computed. The expected rate of return is the weighted average of all possible returns multiplied by their respective probabilities. Thus, probabilities of the various outcomes are used as weights. The expected return, R
The expected rate of return Calculation using the returns for assets X and Y are presented.