A financial investor has an investment portfolio worth $350,000. A bond in the portfolio will mature next month and provide him with $25,000 to reinvest. The choices have been narrowed down to the following two options.
• Option 1: Reinvest in a foreign bond that will mature in one year. This will entail a brokerage fee of $150. For simplicity, assume that the bond will provide interest of $2,450, $2,000, or $1,675 over the one-year period and that the probabilities of these occurrences are assessed to be 0.25, 0.45, and 0.30, respectively.
• Option 2: Reinvest in a $25,000 certificate with a savings-and-loan association. Assume that this certificate has an effective annual rate of
7.5%.
(a) Which form of reinvestment should the investor choose in order to maximize his expected financial gain?
(b) If the investor can obtain professional investment advice from Salomon Brothers, Inc., what would be the maximum amount the investor should pay for this service?