Transcript Document

Problem 3-20: Investment
Strategy for Mickey Lawson
November 2006
Jan White
1
7/17/2015
The Problem
Based on information from Problem 3-19, develop
an opportunity loss table for the investments
Mickey is considering – Stock Market, Bonds, or
Certificates of Deposit (CD’s).
What decision would minimize the expected
opportunity loss?
What is the minimum Expected Opportunity Loss
(EOL)?
Jan White
2
7/17/2015
Decision Model



Decision is being made under risk.
Probabilities are known.
The Decision Model will be the
minimization (“Minimax”) of expected
opportunity loss.
Jan White
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7/17/2015
Data Used for the Decision:
Jan White
State of Nature
State of Nature
Decision
Alternative
Good
Economy
Poor
Economy
Stock Market
$80,000
-$20,000
Bonds
$30,000
$20,000
CD’s
$23,000
$23,000
Probability
0.5
0.5
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Calculations for Each Option under
two States of Nature
State of Nature
State of Nature
Decision
Alternative
Good Economy
Poor Economy
Stock Market
$80,000-$80,000
$23,000–(-$20000)
Bonds
$80,000-$30,000
$23,000-$20,000
CD’s
$80,000-$23,000
$23,000-$23,000
Jan White
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7/17/2015
Total Expected Opportunity Loss
State of Nature
State of Nature
Decision
Alternative
Good
Economy
Poor
Economy
Maximum in
a Row
Stock Market
$0
$43,000
$43,000
Bonds
$50,000
$3,000
$50,000
CD’s
$57,000
$0
$57,000
Probability
0.5
0.5
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Smallest Expected Opportunity Loss Based
on Probability for Each State of Nature:
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Stock Market: $43,000 x 0.5 = $21,500
Bonds: $50,000 x 0.5 = $25,000
CD’s: $57,000 x 0.5 = $28,500
Given the information above, Mickey’s best
decision would be to invest his funds in the
stock market.
Jan White
7
7/17/2015