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Practice Question (With Solution)
Chapter 5
Uncertainty and Consumer Behavior
7. Suppose that two investments have the same three payoffs, but the
probability associated with each payoff differs, as illustrated in the table
below:
Payoff
Probabilities for Investment A
Probabilities for Investment B
$300
0.10
0.30
$250
0.80
0.40
$200
0.10
0.30
a.
Find the expected return and standard deviation of each investment.
The expected value of the return on investment A is
EV
= (0.1)(300) + (0.8)(250) + (0.1)(200) = $250.
The variance on investment A is
σ
2
= (0.1)(300  250)
2
+ (0.8)(250  250)
2
+ (0.1)(200  250)
2
= $500.
The expected value of the return on investment B is
EV
= (0.3)(300) + (0.4)(250) + (0.3)(200) = $250.
The variance on investment B is
σ
2
= (0.3)(300  250)
2
+ (0.4)(250  250)
2
+ (0.3)(200  250)
2
= $1,500.
b.
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This note was uploaded on 04/19/2011 for the course ECON 101 taught by Professor Gul during the Spring '11 term at Lahore School of Economics.
 Spring '11
 gul

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