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.

Answer 1

	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