Question

One of Sam's investments is going to mature, and she wants to determine how to invest the proceeds of $120,000. Sam is considering two new investments: a stock mutual fund and a one-year certificate of deposit (CD). The CD is guaranteed to pay a 1.75% return. Sam estimates the return on the stock mutual fund as 7%, 1.15%, or -9%, depending on whether market conditions are good, average, or poor, respectively. Sam estimates the probability of a good, average, and poor market to be 30%, 45%, and 25%, respectively.

How much should Sam be willing to pay to obtain a market forecast that is 100% accurate?

Answer 1

from the given data,

Decision Alternatives	Market Condition
Good (p=.30)	Average (p=.45)	Poor (p=.25)
Stock Mutual Fund	120,000 x 0.07= 8400	120,000 x 0.0115 = 1,380	120,000 x (-0.09) = - 10800
1 yr CD	120,000 x 0.0175 =2100	120,000 x 0.0175 =2100	120,000 x 0.0175=2100

Expected value under stock mutual fund=0.30*8400+0.45*1380+0.25*(-10800).

Expected value under stock mutual fund=2520+621-2700=441

How much should sam be willing to pay to obtain a market forecast that is 100% accurate

Expected value under 1 year CD - Expected value under stock mutual fund =2100-441=$1659.