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2) yryx Learning Inc-Google Chrome & Secure https://laecon1.lyryx.com/student-servlets/LabServlet?ccid 3427 Question 2 [5 points] You have $2000 to invest and are considering buying some combination of the shares of two companies, Tigerinc and Donkeylnc. Shares of Tigerinc will pay a 5 percent return if the Liberals are elected, an event you believe to have a 80 percent probability; otherwise the shares pay a zero return. Shares of Donkeylnc will pay 10 percent if the Conservatives are elected (a 20 percent probability), zero otherwise. Either the Liberals or the Conservatives will be elected Note: Keep as much precision as possible during your calculations. Your final answer should be accurate to at least two decimal places. a) If your only concern is maximizing your average expected return, with no regard for risk, how should you invest your $2000? Tigerinc 2,000 Donkeyinc S 0 b) Devise an investment strategy that guarantees at least a 3.25 percent return, no matter which party wins the election. Tigerlnc $ 1,300 Donkeylnc S 700 c) Devise an investment strategy that is riskless, that is, one in which the return on your $2000 does not depend at all on which party wins. Tigerlnc $0 Donkeyinc s 00.0 Enter Cancer Official Time: 23:13:51 SUBMIT AND MARK SAVE AND CLOSE

Explanation / Answer

It is certain that either the Liberals or the Conservatives will be elected. Either way, if the Liberals are elected, a guaranteed return of 5% is available and if the Conservatives win, a guaranteed return of 10% is available.

A risk free or riskless strategy is one where investment is divided between both the companies in a way such that the return from both the companies is the same. In other words, the amount of money received in return from TigerInc or DonekyInc will be the same irrespective of whether the Liberals win (such that TigerInc gives the return) or if the Conservatives win (such that DonkeyInc gives the return).

Let the amount to be invested in TigerInc by $x. Therefore the amount invested in DonkeyInc is $(2000-x).

The return from TigerInc is 5% or 0.05*x

The return from DonkeyInc is 10% or 0.1*(2000-x)

Equating both the returns, 0.05x = 0.1*(2000-x)

Or 0.05x = 200-0.1x

Or 0.15x = 200

Or x = $1333

Therefore $2000-1333 = $667

5% return on $1333 = $66.65 and 10% return of $667bis $66.70 which are almost equal.

This means that a riskless investment strategy will be such that $1333 is invested in TigerInc and $667 is invested in DonkeyInc.

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