Explain why expected return is considered forward-looking. What challenges arise in using expected return?

1. Explain why expected return is considered forward-looking. What challenges arise in using expected return?
2. Explain how differences in allocations between the risk-free security and the market portfolio can determine the level of market risk.
Section B
a) Based on the probability and percentage of return for the three economic states in the table below, compute the expected return.
Economic State Probability Percentage of Return
Fast Growth 0.10 60
Slow Growth 0.50 30
Recession 0.40 -23

b) If the risk-free rate is 7% and the risk premium is 4%, what is the required return?
c) Suppose that the average annual return on the Standard and Poor’s 500 Index from 1969 to 2005 was 14.8 percent. The average annual T-bill yield during the same period was 5.6 percent. What was the market risk premium during these 10 years?

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