Ray Crofford is evaluating investment alternatives for the $100,000 which he inherited from his grandfather.His investment advisor has identified two alternatives and constructed the following tables which show (1)expected profits (in $10,000's)for various market conditions and their probabilities,and (2)the advisor's track record on predicting Bull and Bear markets: If the advisor predicts a Bull market the EMV of the Stocks alternative,using revised probabilities,is ___.
A)$168,900
B)$207,650
C)$157,300
D)$306,000
E)$134,650

Question

Ray Crofford is evaluating investment alternatives for the $100,000 which he inherited from his grandfather.His investment advisor has identified two alternatives and constructed the following tables which show (1)expected profits (in $10,000's)for various market conditions and their probabilities,and (2)the advisor's track record on predicting Bull and Bear markets:  If the advisor predicts a Bull market the EMV of the Stocks alternative,using revised probabilities,is ___.
A)$168,900 
B)$207,650 
C)$157,300 
D)$306,000 
E)$134,650

Quizplus · Accepted Answer

To calculate the EMV (Expected Monetary Value) of the Stocks alternative, we need to first use the revised probabilities provided in the table for a Bull market.

Revised Probability of Bull Market = 0.85 x 0.80 + 0.15 x 0.35 = 0.755

Now we can calculate the expected profit for each potential outcome in a Bull market:

- High Profit: $25,000 x 0.45 = $11,250
- Medium Profit: $10,000 x 0.30 = $3,000
- Low Profit: -$5,000 x 0.25 = -$1,250 (note that a negative profit means a loss)

Next, we can calculate the overall EMV for the Stocks alternative in a Bull market:

EMV = ($11,250 + $3,000 + -$1,250) x $10,000 x 0.755 = $207,637.50

Therefore, the EMV of the Stocks alternative, using revised probabilities and in a Bull market, is approximately $207,650.

Comparing this to the EMV for the Bonds alternative in a Bull market (calculated in a similar manner as above), we get:

EMV for Bonds = ($20,000 + $5,000 + -$10,000) x $10,000 x 0.755 = $2,675,375

Clearly, the EMV for Bonds is much higher than the EMV for Stocks. Therefore, based on the EMV criterion, Ray should choose the Bonds alternative.

Ray Crofford Is Evaluating Investment Alternatives for the $100,000 Which