Question

A person invests $1,000 into stock of a company that hopes to go public in one year. The probability that the person will lose all his money after one year (i.e. his stock will be worthless) is 35%. The probability that the person’s stock will still have a value of $1,000 after one year (i.e. no profit and no loss) is 60%. The probability that the person’s stock will increase in value by $10,000 after one year (i.e. will be worth $11,000) is 5%. Find the expected profit after one year.

Answer 1

The expected profit after one year is of $150.

Explanation:

Probabilities after one year:

35% probability of losing $1,000, that is, 35% probability of a profit of -$1,000.

60% probability of still having a value of $1,000, that is, 60% probability of a profit of $0.

5% probability of a increase in value of $10,000, that is, a profit of $10,000.

Find the expected profit after one year.

Each value is multiplied by its probability. So

`E = -0.35*1000 + 0.6*0 + 0.05*10000 = 150`

The expected profit after one year is of $150.