Question

Decisions Involving Uncertainty - End of Chapter Problem

You are analyzing two possible stock market investment strategies. For each of the following, identify whether or not it would be classified as a fair bet. Would a risk-averse person make either of these investments? Why or why not?
a. One strategy is to invest in a blue chip stock like Microsoft that has a proven track record. There is a 25% chance that the company continues its steady growth and your wealth increases by $30,000. There is a 75% chance that the company becomes unprofitable and your wealth decreases by $10,000
The investment in Microsoft ________be a fair bet.
O would
O would not

Answer 1

Investing in the blue chip stock like Microsoft would be classified as a fair bet. However, a risk-averse person would not make this investment due to the high risk involved.

Step-by-step explanation:

To determine whether investing in the blue chip stock like Microsoft is a fair bet or not, we need to calculate the expected value. The expected value is the sum of the product of each outcome and its respective probability. For this investment, the expected value can be calculated as: (0.25 * $30,000) + (0.75 * -$10,000) = $7,500 - $7,500 = $0. Since the expected value is $0, it can be classified as a fair bet.

A risk-averse person would not make this investment. The reason is that a risk-averse person prefers to avoid or minimize risk, and investing in a stock with a 75% chance of decreasing wealth is considered too risky. They would opt for investments with more stable returns and lower risk.