Suppose you visit with a financial adviser, and you are considering investing so

Question

Suppose you visit with a financial adviser, and you are considering investing some of your wealth in one of three investment portfolios: stocks, bonds, or commodities. Your financial adviser provides you with the following table, which gives the probabilities of possible returns from each investment: Stocks Bonds Commodities Probability Return Probability Return Probability Return 10% 12.5% 5% 6% 0.4 0.6 0.3 0.2 0.25 0.25 15% 5% 0.2 0.2 0.25 0.25 20% 15% 6% 0% To maximize your expected return, you should choose O A. commodities O B. stocks O C. bonds 0 D. All of the portfolios have the same expected return.

Explanation / Answer

For maximizing expected return one should choose option A , i.e., commodities in this case.

Explanation -

Expected return in any Investment = r1p1 + r2p2 +.....+ rnpn

here,

r = Return expectation in any time period

p = probability of the return being achieved in that time period

Expected return of any investment is the summation of multiplication of the return expectation and probability of the return being achived for that particular investment portfolio in different time periods.

Stocks

Expected return  

=0.3*(10%) + 0.2*(12.5%) + 0.25*(8%) + 0.25*(6%)

= 3 + 2.5 + 2 + 1.5

= 9 %

Bonds

Expected return

= 0.4*(15%) + 0.6*(5%)

= 6 + 3

= 9

Commodities

Expected return

= 0.2*(20%) + 0.2*(15%) + 0.25*(6%) + 0.25*(4%) + 0.1*(0%)

= 4 + 3 + 1.5 + 1 + 0

= 9.5%

Thus it is clear that investment in commodies gives higgest expected return of 9.5%.

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