9. -/3 points TanFin11 9.5.018 My Notes As part of their investment strategy, th

Question

9. -/3 points TanFin11 9.5.018 My Notes As part of their investment strategy, the Carringtons have decided to put $100,000 into stock market investments and also into purchasing precious metals. The performance of the investments depends on the state of the economy in the next year. In an expanding economy, it is expected that their stock market investment will outperform their investment in precious metals, whereas an economic recession will have precisely the opposite effect. Suppose the following payoff matrix gives the expected percentage increase or decrease in the value of each investment for each state of the economy. Expanding Economic economy recession -15 10 Stock market investment 15 Commodity investment (a) Determine the optimal investment strategy for the Carringtons' investment of $100,000. (Round your answers to the nearest dollar.) stocks commodities $ (b) What profit can the Carringtons expect to make on their investments over the year if they use their optimal investment strategy? (Round your answer to the nearest dollar.)

Explanation / Answer

a) The payoff matrix is given as:

let us consider that the carrigntons decide to invest X dollars into the stock market and 100,000-X into the commodity market.

so in case of the expanding economy the return will be 15x+5(100,000-x)

and in case of economic recession the return will be -15x+10(100,000-x)

for the optimal strategy both should be equal :

15x+5(100,000-x)=-15x+10(100,000-x)

x=14,286(rounded)

100000-x=85,714(rounded)

stock =$14,286

commodity=$85,714

b) The expected profit can be obtained by putting the value of investment in any of the given equation

=(0.15*14,286)+(0.05*85714)

=$ 6,429 (rounded)  is the expected profit

expanding economic recession stock market 15 -15 X commodity 5 10 100,000-X

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