Question

1. Risk-Reward Analysis
                 
Your company plans to invest $1M (one million dollars) and has two different investment opportunities. With opportunity “A” the company profit will be $200K (two hundred thousand dollars) if the market shows a growth, $120K if the market stays stable, and the company will lose $100K if the market declines. With opportunity “B” the company will make $70K profit if the market shows a growth, $50K in a stable market, and the company will lose $10K if the market declines.
Probability for the market growth is 0.45, for the stable market is 0.4, and for the market decline is 0.15.
Conduct a risk-reward analysis and choose opportunity, “A” or “B”. Explain why you made that choice.

Answer 1

Solution :-

Probability of Market Growth = 0.45

Probability of Stable Market = 0.40

Probability of Decline = 0.15

In case of Opportunity A :-

Expected Profit = ( 0.45 * $200 ) + ( 0.40 * $120 ) + ( 0.15 * - $100 )

= $90 + $48 - $15  

= $123 K

In case of Opportunity B :-

Expected Profit = ( 0.45 * $70 ) + ( 0.40 * $50 ) + ( 0.15 * - $10 )

= $31.50 + $20 - $1.50

= $50 K

As we see the Expected Profit in case of Opportunity A is high so Choose that

We Choose it because it gives high reward

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