I don\'t understand what I need to do or how to do it , help please. thanks Imag
ID: 1147521 • Letter: I
Question
I don't understand what I need to do or how to do it , help please. thanks
Imagine that 'almost anything can happen' in the future and that you have an asset whose value depends on exactly what does happen. What is it worth now before we know what does happen? To approach this problem we need to know the value of the asset given what does happen and the probability of the different events that might happen. To make the assignment easier we'll deal with what's known as a discrete probability function over events, that is, there will be a specific number of possible events and each will have a probability assigned to it.1 Maybe you have a Bingo card, depending on what letters and numbers are called (events), your card BINGO! wins a prize or it's valueless Maybe you have a wager on the Eagles to beat the Vikings. If they do, you win $X (X >$0), if they do not, you win $0 Financial assets have values depending on what events take place. The values of ownership of various companies can depend greatly on what happens in a state, region, country and/or the world. Similarly, the value of the right to receive a stream of payments from a firm (that is, the value of that firm's bond) will depend la upon future events. Will the firm stay in existence and thus be able to pay its debtors (bondholders)? Example: Suppose you are part owner of Old MacDonald's Farm' (Inc.), if the weather is "good", farming is successful, a large crop is harvested, and your share of the firm will be valued at $1000. If the weather is “bad", the harvest is zero, and your share of the firm is valued at $200. These are known as "the pay offs" and usually displayed in the "pay-off" matri:x Weather Good Value of Share $1000 $200 Before the growing season, before the weather event, what is the value of your ownership share? $1000? $200. More than $1000? Less than $200? Some value in between? 1The other choice is to use a continuous probability function. The choice above allows the math to be simplified without, I hope, making the illustration vacuous.Explanation / Answer
Good weather. SoSo Weather Bad Weather.
Value. $1000. $500. $200
Answer for Q2
If Pr of SoSo weather is 0.2 then according to the rule of probability,Probability of all possible events should sum to 1
Therefore Pr(SoSo weather)+Pr(Good weather)+Pr(Bad Weather)=1
Pr(Good weather)+Pr(Bad Weather)=1-0.2=0.8
Answer for c)
If Pr(SoSo weather)=0.2 and half of this is 0.1 coming from Pr(Good weather) & Pr(Bad Weather)
New Probabilities are
Pr (Good weather)=0.7 ; Pr(Bad Weather)=0.1; Pr(SoSo weather)=0.2
Expected value=1000×0.7+500×0.2+200×0.1=700+100+40=840
Answer for Q2)
Possible events 1,2,3 & 4.
Answer for a)
Given Probabilities of event 1,2 and 3 that sum to 1(0.5+0.25+0.25=1) hence Prob of event 4 is zero.
Expected value in case a=
0.5×2000+0.25×3000+0.25×4000=1000+750+1000=2750
Expected value in case B
=0.25×(2000+3000+4000+5000)=14000+×0.25=3500
Expected value in case c
=0.5×2000+0.25×3000+0.15×4000+0.1×5000=1000+750+600+500=2850
Expected value of case d
=0.1×2000+0.15×3000+0.25×4000+0.5×5000=200+450+1000+2500=4150
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