The correct answer is:

c. will vary as the probability of each state varies

Explanation:

The expected return of a security depends on the returns in each state of the economy and the probabilities associated with each state. It is calculated as a weighted average of the possible returns, where each return is weighted by the probability of the corresponding economic state.

The formula for the expected return is: $E(R) = \sum_{i=1}^{n} p_i \cdot R_i$ Where:

• $p_i$ = Probability of the economy being in state $i$
• $R_i$ = Return in state $i$
• $n$ = Total number of states

This shows that the expected return will vary if the probabilities $p_i$ change.

Would you like a deeper explanation or have any other questions? Here are 5 related questions you might explore:

1. How do you compute the weighted average return for a set of possible states?
2. What is the difference between arithmetic and geometric averages in finance?
3. How does risk affect the expected return of a security?
4. How do changes in economic conditions impact the expected return?
5. What are some examples of different states of the economy and how they influence returns?

Tip: The arithmetic average is often used to compute the average of historical returns, but for calculating expected return, the weighted average is more appropriate because it considers probabilities.