An investment counselor calls with a hot stock tip. He believes that if the econ

Question

An investment counselor calls with a hot stock tip. He believes that if the economy remains strong, the investment will result in a profit of $50,000. If the economy grows at a moderate pace, the investment will result in a profit of $20,000. However, if the economy goes into recession, the investment will result in a loss of $50,000. You contact an economist who believes there is a 20% probability the economy will remain strong, a 70% probability the economy will grow at a moderate pace, and a 10% probability the economy will slip into recession. What is the expected profit from this investment? The expected profit is $ .

Explanation / Answer

A is the event of economy remaining strong

Probability of economy remaining strong = P(A) = 0.2 (i.e 20/100)

B is the event of economy grows at moderate pace

Probability of economy grows at moderate pace = P(B) = 0.7 (i.e 70/100)

C is the event of economy slips into recession

Probability of economy slips into recession = P(B) = 0.1 (i.e 10/100)

While calculating the expected profit, the losses are put in with a negative sign,

ProfitA = $50,000

ProfitB = $20,000

LossC = -$50,000

expected profit = ProfitA*P(A) + ProfitB*P(B)+LossC*P(C)

expected profit = 50000*0.2 + 20000*0.7 - 50000*0.1= 19000

expected profit = $19,000

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