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QUESTION 16 1
QUESTION 16 1. Exhibit 14.3 The following questions are based on the information below. An investor is considering 4 investments, A, B, C and leaving his money in the bank. The payoff from cach investment is a function of the economic climate over the next 2 years. The economy an expander decline. The following payoff matrix has been developed for the decision problem. The investors estimated the probability of a declining economy at 70% and an expanding economy 30% A B C D E G ? 1 2 Payoff Matrix F Regret Matrix 3 Economy EMV Dedine EOL Investment ? 4 Investment S A € B 7 C E Bank Economy Decline Expand -10 90 20 50 40 45 15 20 ? Bank 10 Probability 0.7 03 Probability 07 2. Refer to Exhibit 14.3. What decision should be made according to the expected monetary we decision rule? ? ? b. ? Bank A
Expert Solution
| According to expected Monetray value decision rule we need to calculated expected value for both the years: | |||||
| Year 1 | |||||
| Investment | Expected Monetary Value | Formula for calculation | |||
| A | 20.00 | (-10*0.70+90*0.30) | |||
| B | 29.00 | (20*0.70+50*0.30) | |||
| C | 41.50 | (40*0.70+45*0.30) | |||
| Bank | 16.50 | (15*0.70+20*0.30) | |||
| Similarly calculate EMV for Year 2: | |||||
| Investment | Expected Monetary Value | Formula for calculation | |||
| A | 20.00 | (-10*0.70+90*0.30) | |||
| B | 29.00 | (20*0.70+50*0.30) | |||
| C | 41.50 | (40*0.70+45*0.30) | |||
| Bank | 16.50 | (15*0.70+20*0.30) | |||
| Summary of total EMV at end of 2 year: | |||||
| Investment | Expected Monetary Value | Decision | |||
| A | 40.00 | Reject as C has higher EMV by 43 | |||
| B | 58.00 | Reject as C has higher EMV 25 | |||
| C | 83.00 | Select as it has higher EMV | |||
| Bank | 33.00 | Reject as C has higher EMV 50 | |||
| Answer is Option b. |
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