Chapter 1. Chapter 20

Step 1

Work It Out
Work It Out
Chapter 20
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Question

You have $1,000 that you can invest. If you buy General Motors stock, then, in one year’s time: with a probability of 0.4 you will get $1,600; with a probability of 0.4 you will get $1,100; and with a probability of 0.2 you will get $800. If you put the money into the bank, in one year’s time you will get $1,100 for certain.

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Step 2

Question

You have $1,000 that you can invest. If you buy General Motors stock, then, in one year’s time: with a probability of 0.4 you will get $1,600; with a probability of 0.4 you will get $1,100; and with a probability of 0.2 you will get $800. If you put the money into the bank, in one year’s time you will get $1,100 for certain.

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Since getting $1,100 for certain is better for you than getting an average (but risky) $1,240, you must be risk-averse: you are willing to take lower (but certain) payoff instead of a higher (but risky) one. For further review see section, “Trading Risk.”
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