Asked by Waldie Alameda on Jun 04, 2024
Verified
Sam,after taking a $200 loan from the bank to finance an investment that pays $1000 50% of the time and $0 50% of the time at a 100% interest,discovers another riskier investment that pays out $5,000 but only 10% of the time,while the other 90% of the time it pays zero.Would the he want to switch to the riskier investment?
A) Yes because his return has increased
B) No because his liability to the bank has increased
C) No because his return has decreased
D) None of the above
Riskier Investment
An investment option that carries a higher probability of losing money but also the potential for higher returns.
Liability
An obligation that an individual or entity has to another individual or entity, often involving the payment of money.
Interest
The cost that creditors charge for use of their capital.
- Comprehend the financial implications of riskier investments and the role of interest rates.
Verified Answer
TL
Thian LianUkJun 06, 2024
Final Answer :
A
Explanation :
The expected return from the first investment is (0.5 * $1000) + (0.5 * $0) = $500. After paying back the $400 loan ($200 principal + $200 interest), Sam is left with $100. The expected return from the riskier investment is (0.1 * $5000) + (0.9 * $0) = $500. After paying back the loan, Sam is left with $100, which is the same as the first scenario. However, the potential payout of $5,000 (even at a 10% chance) represents an increase in potential return, making the riskier investment more attractive for higher potential earnings.
Learning Objectives
- Comprehend the financial implications of riskier investments and the role of interest rates.
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