Bear 13 16 11.5 Question 4. An amateur investor is deciding how to allocate an Return (SK) Market Trend investment of $11,000 between stocks and bonds. She is Bull % Invested in Stocks considering three possible options for how much of her investment to place in stocks: either 25% (option A), 50% (option A: 25% 15 B), or 75% (option C). For each option, the remaining money will B: 50% be invested in bonds. As she is primarily investing in domestic stocks, the performance of her stock portfolio is largely a C: 75% 18 10.5 function of whether the US economy trends up (bull market) or down (bear market) in the coming years. She has created a payoff table of the estimated return on her stock portfolio for each scenario. The expected value of her stock portfolio (in $K) after 2 years under each scenario is shown in the payoff table. a) What is the optimal decision strategy using the optimistic approach? b) What is the optimal decision strategy using the conservative approach? c) What is the optimal decision strategy using the minimax regret approach 24 d) Say the investor believes the probability of a bull market is roughly 30%. Draw a decision tree and use the EMV approach to solve for the "risk-neutral" optimal decision strategy e) Use graphical sensitivity analysis to determine within which range of probability of a bear market each allocation option becomes the optimal choice, if it becomes optimal at all. When graphing your functions, set p as the probability of a bull market. In 2-3 sentences, provide a clear interpretation of your findings. You may use the chart provided as a template EMV Bear 13 16 11.5 Question 4. An amateur investor is deciding how to allocate an Return (SK) Market Trend investment of $11,000 between stocks and bonds. She is Bull % Invested in Stocks considering three possible options for how much of her investment to place in stocks: either 25% (option A), 50% (option A: 25% 15 B), or 75% (option C). For each option, the remaining money will B: 50% be invested in bonds. As she is primarily investing in domestic stocks, the performance of her stock portfolio is largely a C: 75% 18 10.5 function of whether the US economy trends up (bull market) or down (bear market) in the coming years. She has created a payoff table of the estimated return on her stock portfolio for each scenario. The expected value of her stock portfolio (in $K) after 2 years under each scenario is shown in the payoff table. a) What is the optimal decision strategy using the optimistic approach? b) What is the optimal decision strategy using the conservative approach? c) What is the optimal decision strategy using the minimax regret approach 24 d) Say the investor believes the probability of a bull market is roughly 30%. Draw a decision tree and use the EMV approach to solve for the "risk-neutral" optimal decision strategy e) Use graphical sensitivity analysis to determine within which range of probability of a bear market each allocation option becomes the optimal choice, if it becomes optimal at all. When graphing your functions, set p as the probability of a bull market. In 2-3 sentences, provide a clear interpretation of your findings. You may use the chart provided as a template EMV