You have $1,000 to invest and are considering buying some combination of the shares of two companies, Donkeylnc and Elephantine. Shares of Donkeylnc will pay a 10 percent return if the Democrats are elected, an event you believe to have a 40 percent probability; otherwise the shares pay a zero return. Shares of Elephantine will pay 8 percent if the Republicans are elected (a 60 percent probability), zero otherwise. Either the Democrats or the Republicans will be elected.
a. If your only concern is maximizing your average expected return, with no regard for risk, how should you invest your $1,000?
b. What is your expected return if you invest $500 in each stock
c. The strategy of investing $500 in each stock does not give the highest possible average expected return. Why might you choose it anyway?
d. Devise an investment strategy that guarantees at least a 4.4 percent return, no matter which party wins.
e. Devise an investment strategy that is riskless, that is, one in which the return on your $1,000 does not depend at all on which party wins.