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Jen Sites 3-22

Jen Sites 3-22

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Jen Sites 3-22

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  1. Jen Sites 3-22 In problem 3-21 you helped Allen Young determine the best investment strategy. Now, Young is thinking about paying for a stock market newsletter. A friend of Young said that these types of letter could predict very accurately whether the market would be good, fair, or poor. Then, based on these predictions, Allen could make better investment decisions. A. What is the most that Allen would be willing to pay for a newsletter? Jen Sites 3-22

  2. Alternative Market Condition/Good Fair Poor EMV Stock Market 1,400 800 0 880 Bank Deposit 900 900 900 900 Probabilities of Market Conditions 0.4 0.4 0.2 Perfect Information 1400 900 900 1100 Jen Sites 3-22

  3. EMV SOLUTION : STOCK MARKET $1,400 X 0.4 + 800 X 0.4 + 0 X 0.2 = $880 BANK DEPOSIT $900 X 0.4 + 900 X 0.4 + 900 X 0.2 = $900 MAXIMUM EMV IS $900 EVI SOLUTION : expected value with perfect information - max(EMV) = $1400 X 0.4 + 900 X 0.4 + 900 X 0.2 = $1100 - 900 = $200 Jen Sites 3-22

  4. B. Young now believes that a good market will give a return of only 11% instead of 14%. Will this information change the amount that Allen would be willing to pay for the newsletter? If you answer is yes, determine the most that Allen would be willing to pay, given this new information. Jen Sites 3-22

  5. Alternative Market Condition/Good Fair Poor EMV Stock Market 1,100 800 0 760 Bank Deposit 900 900 900 900 Probabilities of Market Conditions 0.4 0.4 0.2 Perfect Information 1100 900 900 980 Jen Sites 3-22

  6. EMV SOLUTION : STOCK MARKET $1,100 X 0.4 + 800 X 0.4 + 0 X 0.2 = $760 BANK DEPOSIT $900 X 0.4 + 900 X 0.4 + 900 X 0.2 = $900 EMV IS $900 EVI SOLUTION : expected value with perfect information - max(EMV) = $1100 X 0.4 + 900 X 0.4 + 900 X 0.2 = $980 - 900 = $80 The answer is yes since EV/PI - max(EMV) is only $80. Jen Sites 3-22

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