Suppose that an investor is considering two portfolios. Portfolio 1 invests $30,

Question

Suppose that an investor is considering two portfolios. Portfolio 1 invests $30,000 in bonds and $10,000 in stocks. Portfolio 2 invests $10,000 in bonds and $30,000 in stocks. Over the investment period the collection of stocks can either increase 15% or decrease by 5% with probabilities .75 and .25. The bonds will either increase by 7% with probability .6, or decrease by 2% with probability .4. (a) There are two decision alternatives. Name them. (b) There are four states of nature. Name them and determine the probabilities for each one. Assume that the probabilities for stocks and bonds are independent. (c) Give the payoff table. (d) Which alternative is best based on the expected payoff criterion?

Explanation / Answer

give the payoff table

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