Question

So Malik is considering investing $900 in a certain company. Financial advisors forecast that there is a 30% chance that the stock will increase in value by 150%, and a 50% chance that he will lose his initial investment. Determine if Malik should make the investment, and find the expected value of the investment.

Answer 1

Answer: B. No, the expected value is –$45

Explanation:

Define three events

A = stock increases in value by 150%

B = stock loses value

C = no change in stock value

Probabilitlies

P(A) = 0.30

P(B) = 0.50

P(C) = 0.20

Net Value

V(A) = 1.5*900 = 1350

V(B) = -900

V(C) = 0

Expected value

E(X) = P(A)*V(A)+P(B)*V(B)+P(C)*V(C)

E(X) = 0.3*1350 + 0.5*(-900) + 0.2*0

E(X) = -45

Malik is expected to lose about 45 dollars on average

He should not make the investment

Answer 2

For the answer to the question above, a 150% increase in value on $900 means there would be a gain of $1350. There's a 30% chance this will happen.
Losing the entire investment means a loss of $900. There' a 50% chance this will happen.


The expected gain/loss is ∑ P(X)*X = .3(+1350) + .5(-900) = +405 - 450 = -45. That means the expected value is $900 - 45 = $855, which means he should NOT make the investment [D]