Ms. Q would like to invest $100,000. She could invest in Bonds, Credit Derivativ

Question

Ms. Q would like to invest $100,000. She could invest in Bonds, Credit Derivatives, or in Real Estate. The market for each investment is uncertain, and will be either Good, Fair or Poor. The probabilities of these are 0.3, 0.5, and 0.2 respectively. Ms. Q will have the following rates of return if she invest in Bonds: 5% in a good market, 2% in a fair market and -2% in a poor market. Similarly for Credit derivatives, the returns will be 6%, 1.5%, and -2.5%, and for Real Estate 10%, 1% and -8% (in a good, fair and poor market repsecitvely). Based on Expected Monetary Value, what investment should Ms. Q choose? If the probabilities for a good, fair or poor market become 0.6, 0.1, 0.3 respectively, what investment would be best? Develop the decision tables to solve and answer these questions.

Explanation / Answer

Credit derivatives should be chosen

Investment in real estate should be chosen

Market Probability Return Bonds Return Credit derivatives Return Real Estate Expected Return Bonds Expected Return Credit Derivatives Expected return real estate Good 0.3 5% 6% 10% 1.50% 1.80% 3.00% Fair 0.5 2% 1.50% 1% 1.00% 0.75% 0.50% Poor 0.2 -2% -2.50% -8% -0.40% -0.50% -1.60% Expected Return 2.10% 2.05% 1.90%

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