A stock market investor has $500 to spend and is considering purchasing an option for $100, and shares of Apricot Computer with the remaining amount. The shares themselves are currently selling for $30 per share. Apricot is involved in a lawsuit, the outcome of which will be known after one year. If the outcome is in Apricot's favor, analysts expect Apricot's stock price to increase by $10 per share. If the outcome is unfavorable, the price is expected to drop by $10 per share. Owning the option would allow the investor to hedge against any loss of the Apricot stock value; that is, the initial investment (shares) can be recovered at the current price if Apricot lose the case. Aside from purchasing the option, the investor could (i) do nothing and earn about 8% on his money after one year, or (ii) purchase just $500 worth of Apricot shares. Assume that any fractional share can be purchased.

a) Construct a decision tree and cumulative risk profiles for the three alternatives, assuming Apricot has a 70% chance of winning the lawsuit. Which alternative is the best in terms of EMV at one year?

b) If the investor believes that Apricot stands a 50% chance of winning the lawsuit, which alternative is the best in terms of EMV at one year? Identify any (stochastic or deterministic or no) dominance, if it exists, among the alternatives.