An investment in a stock may result in various possible values. Consider two equity stocks, Mercury Company Ltd and Zenith Company Limited. Mercury Company Ltd may provide a return of 15%, 20% or 25% with certain probabilities associated with them, based on the state of the economy. The stock Zenith Company Limited, being more volatile, earn a return of – 18%,15% or 38% with the same probabilities, based on the state of the economy.
The probability of an event represents the likelihood of its occurrence. Suppose you say that there is a 4 to 1 chance that the market price of a stock A will rise during the next fortnight. This implies that there is an 80% chance that the price of stock A will increase and a 20 % chance that it will not increase during the next fortnight.