Question

shir khan is considering investing some money. The following payoff table gives the profit that would be realized during the next year for each of the three investment alternatives. State of Nature Alternative Good Economy Poor Economy Stock Market 80,000 -20,000 Bonds 30,000 20,000 CDs 23,000 23,000 Probability 0.6 0.4 a) Under Maximax which would be the best investment opportunity? b) Under Maximin which would be the best investment opportunity? c) Under equally likely which would be the best investment opportunity? d) Under Risk which would be the best investment opportunity?

Answer 1

a)

Under Maximax approach, we choose the maximum of maximum payoffs.

The maximum payoffs for Stock Market is 80,000.

The maximum payoffs for Bonds is 30,000.

The maximum payoffs for CDs is 23,000.

The maximum of maximum payoffs is 80,000 for Stock Market.

The best investment alternatives under Maximax is Stock Market.

b)

Under Maximin approach, we choose the maximum of minimum payoffs.

The minimum payoffs for Stock Market is -20,000 .

The minimum payoffs for Bonds is 20,000.

The minimum payoffs for CDs is 23,000.

The maximum of minimum payoffs is 23,000 for CDs

The best investment alternatives under Minimax is CDs.

c)

Under equally likely,

The payoff for Stock Market = (80,000 -20,000) / 2 = 30,000

The payoff for Bonds = (30,000 + 20,000) / 2 = 25,000

The payoff for CDs = (23,000 + 23,000) / 2 = 23,000

The maximum payoffs is 30,000 for Stock Market.

The best investment alternatives under equally likely is Stock Market.

d)

Expected monetary value (EMV) for Stock Market = 0.6 * 80,000 - 0.4 * 20,000 = 40,000

Expected monetary value (EMV) for Bonds = 0.6 * 30,000 + 0.4 * 20,000  = 26,000

Expected monetary value (EMV) for CDs = 0.6 * 23,000 + 0.4 * 23,000 = 23,000

The maximum EMV is 40,000 for Stock Market.

The best investment alternatives under risk is Stock Market.