Ellie Daniels has $200,000 and is considering three mutual funds for investment—a global fund, an index fund, and an Internet stock fund. During the first year of investment, Ellie estimates that there is a .70 probability that the market will go up and a .30 probability that the market will go down. Following are the returns on her $200,000 investment at the end of the year under each market condition: Market Conditions Fund Up Down Global $25,000 $ -8,000 Index 35,000 5,000 Internet 60,000 -35,000 At the end of the first year, Ellie will either reinvest the entire amount plus the return or sell and take the profit or loss. If she reinvests, she estimates that there is a .60 probability the market will go up and a .40 probability the market will go down. If Ellie reinvests in the global fund after it has gone up, her return on her initial $200,000 investment plus her $25,000 return after 1 year will be $45,000. If the market goes down, her loss will be $15,000. If she reinvests after the market has gone down, her return will be $34,000, and her loss will be $17,000. If Ellie reinvests in the index fund after the market has gone up, after 2 years her return will be $65,000 if the market continues upward, but only $5,000 if the market goes down. Her return will be $55,000 if she reinvests and the market reverses itself and goes up after initially going down, and it will be $5,000 if the market continues to go down. If Ellie invests in the Internet fund, she will make $60,000 if the market goes up, but she will lose $35,000 if it goes down. If she reinvests as the market continues upward, she will make an additional $100,000; but if the market reverses and goes down, she will lose $70,000. If she reinvests after the market has initially gone down, she will make $65,000, but if the market continues to go down, she will lose an additional $75,000. Using decision tree analysis, determine which fund Ellie should invest in and its expected value.
Ellie Daniels has $200,000 and is considering three mutual funds for investment—a global fund,
an index fund, and an Internet stock fund. During the first year of investment, Ellie estimates
that there is a .70 probability that the market will go up and a .30 probability that the market will
go down. Following are the returns on her $200,000 investment at the end of the year under each
market condition:
Market Conditions
Fund Up Down
Global $25,000 $ -8,000
Index 35,000 5,000
Internet 60,000 -35,000
At the end of the first year, Ellie will either reinvest the entire amount plus the return or sell
and take the profit or loss. If she reinvests, she estimates that there is a .60 probability the market
will go up and a .40 probability the market will go down. If Ellie reinvests in the global fund after
it has gone up, her return on her initial $200,000 investment plus her $25,000 return after 1 year
will be $45,000. If the market goes down, her loss will be $15,000. If she reinvests after the market
has gone down, her return will be $34,000, and her loss will be $17,000. If Ellie reinvests in
the index fund after the market has gone up, after 2 years her return will be $65,000 if the market
continues upward, but only $5,000 if the market goes down. Her return will be $55,000 if she
reinvests and the market reverses itself and goes up after initially going down, and it will be
$5,000 if the market continues to go down. If Ellie invests in the Internet fund, she will make
$60,000 if the market goes up, but she will lose $35,000 if it goes down. If she reinvests as the
market continues upward, she will make an additional $100,000; but if the market reverses and
goes down, she will lose $70,000. If she reinvests after the market has initially gone down, she
will make $65,000, but if the market continues to go down, she will lose an additional $75,000.
Using decision tree analysis, determine which fund Ellie should invest in and its expected value.
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