You have the chance to invest your money in either a 7.5% bond that sells at face value or an aggressive growth stock that pays only 1% dividend. If inflation occurs, the interest rate will go up to 8%, in which case the principal value of the bond will go down by 10%, and the stock value will go down by 20%. If recession materializes, the interest rate will go down to 6%. In this case, the principal value of the bond is expected to go up by 5%, and the stock value will increase by 2%. If the economy remains unchanged, the stock value will go up by 8%, and the bond principal value will remain the same. Economists estimate a 20% chance of inflation and 15% of recession. You are basing your investment decision on next year’s economic conditions.

(a) Represent the problem as a decision tree.

(b) Would you invest in stocks or bonds?