Consider an economy with two types of firms, S and I. S firms always move together, but I firms

move independently of each other. For both types of firms there is a 20% probability that they

will have a 20% return and a 80% probability that they will have a - 30% return.

What is the expected return for an individual firm?

A) - 12%

B) - 20%

C) 10%

D) 20%

option (B) - 20%

Explanation:

Data provided in the question:

Return Probability

20% 20%

-30% 80%

Now,

Expected return for an individual firm = ∑ (Return * Probability)

or

Expected return for an individual firm = (0.20 * 0.20) + (-0.30 * 0.80)

or

Expected return for an individual firm = 0.04 + ( - 0.24)

or

Expected return for an individual firm = - 0.2

or

Expected return for an individual firm = - 20%

Hence,

The correct answer is option (B) - 20%