An investor is debating which of two investments to pursue: a stock or a bond. T

Question

An investor is debating which of two investments to pursue: a stock or a bond. The stock investment is more risky in terms of having more downside (and upside) potential, depending on future market conditions which are uncertain at this time. The stock is projected to earn a $16,000 profit if market conditions are favorable but will result in a $11,000 loss if market conditions are unfavorable. The bond is projected to earn a $8,500 profit if market conditions are favorable or a $3,000 loss if market conditions are unfavorable. At this time, the probability of favorable market conditions is estimated to be 0.50, and the probability of unfavorable market conditions is estimated to be 0.50.

a. Compute the expected profit for the stock investment.

Enter your answer as a whole number.

Expected profit for stock investment = $ ___________

b. Compute the expected profit for the bond investment.

Enter your answer as a whole number.

Expected profit for bond investment = $ ___________

c. Assume that the investor is "risk neutral." "Risk neutral" means that he/she makes decisions based only on the expected value of the decision under consideration. In this case, which alternative (stock or bond) should the investor choose?

A). Bond investment

B.) Stock investment

Explanation / Answer

a) Expected profit for stock investment = 0.5x16000 - 0.5x11000

= $2500

b) Expected profit for bond investment = 0.5x8500 - 0.5x3000

= $2750

c) B. Stock investment

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