Market observers are quite uncertain whether the stock market has bottomed out f

Question

Market observers are quite uncertain whether the stock market has bottomed out from the economic meltdown that began in 2008. In an interview on March 8, 2009, CNBC interviewed two prominent economists who offered differing views on whether the U.S. economy was getting stronger or weaker. An investor not wanting to miss out on possible investment opportunities considers investing $20,000 in the stock market. He believes that the probability is 0.29 that the market will improve, 0.35 that it will stay the same, and 0.36 that it will deteriorate. Further, if the economy improves, he expects his investment to grow to $26,000, but it can also go down to $14,000 if the economy deteriorates. If the economy stays the same, his investment will stay at $20,000. a. What is the expected value of his investment? Expected value $ b. What should the investor do if he is risk neutral? Investor invest the $20,000. c. Is the decision clear cut if he is risk averse? No Yes

Explanation / Answer

the probability on return are given

a) E(X) = X1*P(X1) + X2*P(X2)+......+XN*P(XN)

HERE E(X) = 26000(0.29) +14000*(0.36) + 20000*(0.35) = 19580

B) AS PER THE PROBABILITY EVEN IF THE MARKET REMAIN AS PER THE PROBABILITY THEN HE WILL FACE THE MINOR LOSS OF 420 BUT AS THE CHANCES ARE THERE FOR MARKET TO GROW THEN THE INVESTOR WILL SURELY INVEST

C) NO, THE ANSWER ISNOT CLEAR CUT IT IS BASED ON THE PROBABILITY AND THE SCOPE OF RETURNS

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