Assume that the investor is aware, as well as, is willing to pay for market forecasts to revise the probabilities of the economic condition. Indeed, he/she is aware that Bayess theorem can be used to revise the probabilities associated with the state of the economic conditions. The market forecast will cost $100 dollars (roughly per $1000 investment for the forecast. Assume that such a forecast can predict either an expanding economy (F1), a declining or stagnant economy (F2). Past experience of the consultant indicates that, when there is a recession, prior forecast predict an expanding economy 20% of the time. When there is stable economy, prior forecasts predicted an expanding economy 40% of the time. When there is a moderate growth, prior forecasts predicted an expanding economy 70% of the time. Finally, when there is a boom economy, prior forecasts predicted an expanding economy 90% of the time.

Let event S1 = recession; event S2 = stable economy; event S3 =moderate growth, and S4 = boom economy.

Question 1: Based on the information stated above, provide the simple and conditional probabilities described in the information provided above.

Question 2: Using Bayes theorem, compute the posterior probabilities (P(Si/ Fi)for each.

Question 3a: Use the results from question 6, compute the EMVs for the two decision alternatives and indicate the best course of action you would recommend to the investor. Explain the rational of your decision.

Question 3b: Expand the decision tree (you developed in Question 1) to provide the results of your calculations to questions 2 and 3 .

Question 8: Compute the coefficient of variation in the return of stock A and stock B. (Hint: The interest is on the variability of the payoffs. Please review Section 2.6 of the textbook to refresh on the calculation of variance of a discrete probability distribution.)

Question 9: Compute the return-to-risk ratios for each investment alternatives A and B. Explain which alternative you would recommend to the investor. (Hint: The risk-to-return ratio is computed by dividing the standard deviation of the expected payoff by the related EMA).

Question 10a: Compute the EVPI and the EVSI, as well as the Efficiency of Sample Information, and explain the meaning of their values to the investor.

Question 10b: Conduct a sensitivity analysis under the assumption of a stable economy, and provide sensitivity graph, of the investors decision based on the probability of the state of the economy. (Hint: Review Section 3.5 of the textbook.)