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Scenario: Diversification
Morris is considering investing $10,000 in a sunglass company or a rain poncho company. If it is a rainy year and he invests only in the sunglass company, he will lose $5,000. However, if it is a rainy year and he invests only in the rain poncho company, he will earn $10,000. If it is a sunny year and he invests only in the sunglass company, he will earn $10,000; if he invests only in the rain poncho company, he will lose $5,000 in a sunny year. There is a 50% chance of a sunny year and a 50% chance of a rainy year.
-(Scenario: Diversification) Look at the scenario Diversification. If Morris invests half of his money in the sunglass company and half in the rain poncho company, what is his expected gain or loss?
A) a loss of $2,500
B) to break even
C) a gain of $2,500
D) a gain of $10,000

Question

Quizplus · Accepted Answer

If Morris invests half of his money in the sunglass company and half in the rain poncho company, he will earn $5,000 in a rainy year and $5,000 in a sunny year. Since there is a 50% chance of a rainy year and a 50% chance of a sunny year, his expected gain is $5,000 * 0.5 + $5,000 * 0.5 = $5,000.

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