XYZ Company is considering three investments to invest $100,000: Bond, Stock mut

Question

XYZ Company is considering three investments to invest $100,000: Bond, Stock mutual fund, fixed deposits:* The fixed deposits guaranteed to pay 5.5% return Stock mutual fund as 12%, 9% or-2% depending on whether market conditions are: good, average, or poor. Bond 10%,8.7% or 3% depending on whether market conditions are: good, average, or poor. XYZ company estimated the probability of a good, average, and poor market to be 0.3,0.5, and 0,2 respectively.+ . Q3-1. What decision should be made according to the EMV decision rule? Q3-2. What decision should be made according to the EOL (expected opportunity loss). Q3-3. How much XYZ company should be willing to pay to obtain a market forecast Q3-4. Draw a decision tree to this problem decision rule? that is 100% accurate.

Explanation / Answer

Ques 1) Expected Monetary Value = Probability * Impact

Explanation:

we assume investmnet done 50% on both market effected funds i.e., MF and Bonds. then we calculate interest recd out of both options by multiplying ROI with amount which is $50,000.00, and both the amount multiplied by probability to get the expected value of future returns in different scenerion.

Hence, 2nd option gives highest expected retuen which is $4,425, by investing 50-50 % on both the schemes. So, recommended option is investing in average fund options as per given calculations.

OR

Going for bonds is better option as it gives higher EMV of 7.95%, whereas other option gives 7.7% EMV.

ques 2) EOL (Expected Opportunities loss)

Caculations= column 1= choose highest value and deduct all three values from them, one of them will definitely be zero.

same with column 2= choose highest value and deduct all three values from them, one of them will definitely be zero.

After that: 0*30+3*50+14*20 for MF =4.3%

                0*30+1.3*50+7*20 for Bonds=2.05%

Decision Making

EOl should always be minimum. As we can see FD has minimum EOL, but doesn't include market risk. Hence, this is not the part of the game. Comparing other two options, XYZ should consider Bonds (this time too), as giving minimum EOL which is 2.05%.

Question 3) For 100% accuracy, company should not pay anything becasue there is no 100% accurate market forecast, either it could go for Fixed Deposits to get highest rate of accuracy.

Question 4)

Getting Value 7.7 in EMV hence decision tree for same would be=

for 7.95 would be

7.95= 30%, =12

7.95 =50% =9

7.95  =20% =-2

for 7.7 would be

7.7= 30%, =10

7.7 =50% =8.7

7.7  =20% =3               (Note: as unable to upload imag, the decision tree explained like this)

Investment amount $100,000 scenerio Mutual fund Bond EMV ROI IN % AMOUNT ROI IN Amont ROI IN % AMOUNT ROI IN Amont (MF + Bond)* probability Good 30% 12% 50,000 6,000 10% 50,000 5000 3,300 average 50% 9% 50,000 4,500 8.70% 50,000 4350 4,425 poor 20% -2% 50,000 -1,000 3% 50,000 1500 100 Lets asssume 50% invested in both market linked options

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