Textbook Problem

An investor with $10,000 available to invest has the following options: (1) he can invest in a risk-free savings account with a guaranteed 3% annual rate of return; (2) he can invest in a fairly safe stock, where the possible annual rates of return are 6%, 8%, or 10%; or (3) he can invest in a more risky stock, where the possible annual rates of return are 1%, 9%, or 17%. The investor can place all of his available funds in any one of these options, or he can split his $10,000 into two $5000 investments in any two of these options. The joint probability distribution of the possible return rates for the two stocks is given in the file P09_34.xlsx.

1. a. Use PrecisionTree to identify the strategy that maximizes the investor’s expected one-year earnings.
2. b. Perform a sensitivity analysis on the optimal decision, letting the amount available to invest and the risk-free return both vary, one at a time, plus or minus 100% from their base values, and summarize your findings.