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Question
Rates of return

The accountant for ByComputers has $100Million in excess monies to invest. His orders to invest the whole dollar amount for one year in either bonds or stocks (but not both) and then to reinvest the entire fund in either bonds or stocks (but not both) for one year or more. The premise is try and maximize the expected monies value of the fund at the end of the 2nd year.

The annual rates of return on these investments depend on the economic environment as below:

Rate of return

Economic Environment Stocks Bonds

Growth 20% 5%

Recession -10 10

Depression -50 20

The probabilities of growth, recession, and the depression for the first year are as follows

0.7 , 0.3, and 0, respectively. If growth occurs in the first year, these probabilities remain the same for the second year. But, if there is a recession that occurs in the first year, these probabilities change to 0.2, 0.7, and 0.1, respectively, for the 2nd year.

*Please create a decision tree that shows the logical sequence of the decision problem with recommendation of whether ByComputers should initially invest in bonds or stocks?

Present a strategy table for various values associated with the 1st year growth probability.

 

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