Answer to Question #295236 in Statistics and Probability for Nicole Nelson

Question

Nicole Nelson has come into an inheritance from her grandparents. She is attempting to decide among several investment alternatives. The return after one year is dependent primarily on the interest rate during the next year. The rate is currently 7%, and she anticipates it will stay the same or go up or down by at most 2 points. The various investment alternatives plus their returns ($10,000s) given the interest rate changes are shown in the following table. Interest Rates Investments 5% 6% 7% 8% 9% Money market fund 1.7 2.8 3.0 3.6 4.5 Stock growth fund -5 -3 3.5 5 7.5 Bond fund 5 4 3.5 3 2 Government fund 4 3.6 3.2 2.8 2.1 Risk fund -12 -7 4.2 9.3 16.7 Savings bonds 3 3 3.2 3.4 3.5

Answer 1

This method will use weighted average approach. Weighted average for an investment= sum of (probability*return)

For example, for money market fund, weighted average = 0.1*1.7 + 0.2*2.8 + 0.4*3 + 0.2*3.6 + 0.1*4.5 = 3.10

"Risk fund" is the best investment as it has the highest expected value of 7.81%.

expected value = weighted average, using the probabilities as weights.