What does an arithmetic mean signify in finance?

Prepare for the Corporate Finance Exam with targeted flashcards and multiple choice questions. Each question includes hints and explanations. Ensure success with our comprehensive study resources!

The arithmetic mean in finance signifies the average of a set of returns, calculated by summing all the individual returns and then dividing by the number of returns. This measure provides a straightforward way to assess and summarize the overall performance of an investment or portfolio over a specific period. It is particularly useful in scenarios where returns are being compared, as it grants a clear understanding of expected performance based on individual data points.

For example, if an investor has returns of 5%, 10%, and 15% over three years, the arithmetic mean would be (5% + 10% + 15%) / 3, which equals 10%. This value indicates the average annual return an investor can expect based on the past performance of those returns. It’s a fundamental concept in finance as investors often use it to gauge the expected performance of assets and make decisions based on average historical returns.

Other choices represent different financial concepts. Compounded growth over time pertains to geometric means, the highest return achieved relates to a peak performance metric, and average risk concerns variance or standard deviation of returns, which are distinct elements in financial analyses.

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