Depict the following situation as a game in extensive form. Jill (Player I) has

Question

Depict the following situation as a game in extensive form. Jill (Player I) has $100,000 at her disposal, which she would like to invest. Her options include investing in gold for one year; if she does so, the expectation is that there is a probability of 30% that the price of gold will rise, yielding Jill a profit of $20,000, and a probability of 70% that the price of gold will drop, causing Jill to lose $10,000. Jill can alternatively invest her money in shares of the Future Energies corporation; if she does so, the expectation is that there is a probability of 60% that the price of the shares will rise, yields Jill a profit of $50,000, and a probability of 40% that the price of the shares will drop to such an extent that Jill will lose her entire investment. Another option open to Jill is placing the money in a safe index-linked money market account yielding a 5% return.

Explanation / Answer

Wehave 3 available options - Amount of investment = 100000 (i) Investment in gold = Probability Expested Result Cash flow Expected value = Prob. X Cash flow 0.3 Profit 20000 120000 36000 0.7 Loss 10000 90000 63000 99000 Expected Return = (99000-100000)/100000 x 100 = -1.0% (ii) Investment in shares Probability Expested Result Cash flow Expected value = Prob. X Cash flow 0.6 Profit 50000 149000 89400 0.4 Loss 100000 0 0 89400 Expected Return = (89400-100000)/100000 x 100 = -10.6% (iii) Money safe index = Yield = 5% Since the third option yields maximum it should be choosen

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