Suppose that you are trying to decide whether to spend $1,000 on stocks issued by Wild Web or on bonds issued by the same company. There is a 50 percent chance that the value of the stock will rise to $2,200 at the end of the year and a 50 percent chance that the stock will be worthless at the end of the year. The bonds promise an interest rate of 20 percent per year, and it is certain that the bonds and interest will be repaid at the end of the year. a. Assuming that your time horizon is exactly one year, will you choose the stocks or the bonds?
b. By how much is your expected end-of-year wealth reduced if you make the wrong choice?
c. Suppose the odds of success improve for Wild Web: Now there is a 60 percent chance that the value of the stock will be $2,200 at year’s end and only a 40 percent chance that it will be worthless. Should you now choose the stocks or the bonds?
d. By how much did your expected end-of-year wealth rise as a result of the improved outlook for Wild Web?