# Question: Consider an investor with 10 000 available to invest He has

Consider an investor with $10,000 available to invest. He has the following options regarding the allocation of his available funds:

(1) He can invest in a risk-free savings account with a guaranteed 3% annual rate of return;

(2) He can invest in a fairly safe stock, where the possible annual rates of return are 6%, 8%, or 10%; or

(3) He can invest in a more risky stock, where the possible annual rates of return are 1%, 9%, or 17%. Note that the investor can place all of his available funds in any one of these options, or he can split his $10,000 into two $5000 investments in any two of these options. The joint probability distribution of the possible return rates for the two stocks is given in the file P06_41.xlsx.

a. Create a payoff table that specifies this investor’s return (in dollars) in one year for each possible decision and each outcome with respect to the two stock returns.

b. Use Precision Tree to identify the strategy that maximizes the investor’s expected earnings in one year from the given investment opportunities.

c. Perform a sensitivity analysis on the optimal decision, letting the amount available to invest and the risk-free return both vary, one at a time, plus or minus 100% from their base values, and summarize your findings.

(1) He can invest in a risk-free savings account with a guaranteed 3% annual rate of return;

(2) He can invest in a fairly safe stock, where the possible annual rates of return are 6%, 8%, or 10%; or

(3) He can invest in a more risky stock, where the possible annual rates of return are 1%, 9%, or 17%. Note that the investor can place all of his available funds in any one of these options, or he can split his $10,000 into two $5000 investments in any two of these options. The joint probability distribution of the possible return rates for the two stocks is given in the file P06_41.xlsx.

a. Create a payoff table that specifies this investor’s return (in dollars) in one year for each possible decision and each outcome with respect to the two stock returns.

b. Use Precision Tree to identify the strategy that maximizes the investor’s expected earnings in one year from the given investment opportunities.

c. Perform a sensitivity analysis on the optimal decision, letting the amount available to invest and the risk-free return both vary, one at a time, plus or minus 100% from their base values, and summarize your findings.

**View Solution:**## Answer to relevant Questions

A buyer for a large department store chain must place orders with an athletic shoe manufacturer six months prior to the time the shoes will be sold in the department stores. In particular, the buyer must decide on November 1 ...Consider a population of 2000 individuals, 800 of whom are women. Assume that 300 of the women in this population earn at least $60,000 per year, and 200 of the men earn at least $60,000 per year. a. What is the probability ...The senior executives of an oil company are trying to decide whether to drill for oil in a particular field in the Gulf of Mexico. It costs the company $600,000 to drill in the selected field. Company executives believe that ...Consider again the bank’s customer loan decision problem in Problem 51. Suppose now that the bank’s utility function of profit x (in dollars) is U(x) = 1 – e-x/500000. Find the strategy that maximizes the bank’s ...A retired partner from a large brokerage firm has one million dollars available to invest in particular stocks or bonds. Each investment’s annual rate of return depends on the state of the economy in the coming year. The ...Post your question