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Bank A offers an interest rate of ra = 5% per annum with continuous compounding. Bank B offers simple annual compounding but the interest rate is rg = 1% with prob- ability p and rB = %3D 8% otherwise. You wish to invest Bo = £1000 for a duration of 1 year. (a) Find the value of p (say p') so that the the return from Bank A is equal to the expected return of Bank B. (Hint The return of Bank B is a discrete random variable.) (b) Suppose that p = p". Which bank do you prefer? Briefly justify your answer.

Bank A offers an interest rate of ra = 5% per annum with continuous compounding. Bank B offers simple annual compounding but the interest rate is rg = 1% with prob- ability p and rB = %3D 8% otherwise. You wish to invest Bo = £1000 for a duration of 1 year. (a) Find the value of p (say p') so that the the return from Bank A is equal to the expected return of Bank B. (Hint The return of Bank B is a discrete random variable.) (b) Suppose that p = p". Which bank do you prefer? Briefly justify your answer.

A First Course in Probability (10th Edition)
A First Course in Probability (10th Edition)
10th Edition
ISBN:9780134753119
Author:Sheldon Ross
Publisher:Sheldon Ross
Chapter1: Combinatorial Analysis
Section: Chapter Questions
Problem 1.1P: a. How many different 7-place license plates are possible if the first 2 places are for letters and...
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1. Bank A offers an interest rate of ra = 5% per annum with continuous compounding. Bank B offers simple annual compounding but the interest rate is ra = 1% with prob- ability p and rB = 8% otherwise. You wish to invest Bo %3D = £1000 for a duration of 1 year. (a) Find the value of p (say p") so that the the return from Bank A is equal to the expected return of Bank B. (Hint: The return of Bank B is a discrete random variable.) (b) Suppose that p = p". Which bank do you prefer? Briefly justify your answer.
Transcribed Image Text:1. Bank A offers an interest rate of ra = 5% per annum with continuous compounding. Bank B offers simple annual compounding but the interest rate is ra = 1% with prob- ability p and rB = 8% otherwise. You wish to invest Bo %3D = £1000 for a duration of 1 year. (a) Find the value of p (say p") so that the the return from Bank A is equal to the expected return of Bank B. (Hint: The return of Bank B is a discrete random variable.) (b) Suppose that p = p". Which bank do you prefer? Briefly justify your answer.
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