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TeachMeFinance.com
Probability Distribution
Probability Distribution- The weather this
weekend
| Outcome | Probability |
| Sunny | 80 % |
| Rain | 10 % |
| Snow | 9.99995 % |
| Volcanic Ash | 0.00005 % |
The total must equal 100%
Probability Distribution - In Business
| Economic Outcome | Probability | Return on Investment |
| Great | 20% | 25% |
| Good | 40% | 15% |
| So-So | 30% | 5% |
| Really Bad | 10% | 0% |
- Economic Outcome = What might happen next year to the country's overall economy.
- Probability = Estimate of the likelihood that the economy will be in each outcome.
- Return on Investment = Estimate of your profit in each economic outcome.
Taking a Weighted Average - Expected Rate of Return (ERR)
What is the most likely return on your investments next year? Just multiply it out and add.
| Probability | Times | Outcome | Equals | Result |
| 20% | X | 25% | = | 5% |
| 40% | X | 15% | = | 6% |
| 30% | X | 5% | = | 1.5% |
| 10% | X | 0% | = | 0% |
| Total | 12.5% |
So after taking a weighted average the Expected Rate of Return (ERR) is 12.5%
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