Alex is a risk adverse investor. He has $30,000 to invest for one year. He has two choices:

Choice #1: Buy shares of Paramount Components Inc. (PC); which can payoff

• $ 1,600 if PC is in a high payoff state (H) and
• $ 0 if PC is in a low payoff state (L)

Choice #2: Buy a GIC with a guaranteed payoff of $ 64

Alexs prior probabilities on the future state of PC are:

P(H) = 0.30

P(L) = 0.70

Alexs utility is equal to the square root of the amount of the payoff.

Required: (Show all your calculations)

1. Which choice of investment would Alex prefer; Shares of PC or GIC? (4 marks)

1. Before making the investment Alex decides to become more informed. He studies the annual report of PC that has just been released and discovers that PC has had a Good year and the financial statement show Good news. Alex discusses his findings with an investment advisor who comes up with the following probabilities.

P(GN/L) = 0.1

P(GN/H) = 0.9

Prepare the information system (2marks),

Indicate which choice of investment will Alex now prefer? (4 marks)