Final answer:
The expected profit from investing $1,000 in stock with given probabilities is $150 after one year. Additionally, compound interest can significantly increase an initial investment over time, as shown in the example where $3,000 grows to $44,923 in 40 years at a 7% annual rate of return.
Step-by-step explanation:
In investing, the expectation of return plays a significant role in decision-making. When investing, for example, $1,000 in stock with a potential public offering in a year, different outcomes have to be considered. Based on the probabilities given, we can calculate the expected profit (EP).
EP = (Probability of a loss × Loss amount) + (Probability of no profit/no loss × Amount) + (Probability of a gain × Gain amount)
EP = (0.35 × -$1,000) + (0.60 × $0) + (0.05 × $10,000)
EP = -$350 + $0 + $500
EP = $150
The expected profit after one year would be $150.
Additionally, understanding the power of compound interest is vital for long-term investment success. For example, when saving $3,000 at a 7% annual rate of return and letting it grow for 40 years without additional contributions, the formula for compound interest shows significant growth:
3,000(1+.07)40 = $44,923
This demonstrates the substantial impact that both compound interest and the passage of time can have on an initial investment.