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# Stock Market and Decision Tree Analysis

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Mr. T must decide whether to invest \$10,000 in the stock market (SM) or saving bond (SB) at an interest rate of 8%. If he invests in the stock market for a year and the market is good, he could get a 12% return on his money. On the other hand, if the market is bad, he will get nothing. Suppose there is a 60% chance of a good market.

Question:
(a) Draw a decision tree. What is the optimal decision, and what is the expected reward from making this decision?
(b) An expert, Dr. Excellent is good at predicting the stock market. Base on his previous experience, when the market was good, 85% of the time he predicated "X Market". When the market was bad, 80% of the time he predicted "Y Market". Suppose Mr. T hires Dr. Excellent to be his consultant, how much is Dr. Excellent advice worth? Lay out the answer at the decision tree.

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#### Solution Preview

These are the events that could happen for each of the choices
These are Mr. T's 2 choices Expected Reward

0.5
Market is good Conclusion:
\$1,200.00 For the Mr. T should invest in the savings bond
Invest in SM \$1,200.00 1200 which ...

#### Solution Summary

Stock market and decision tree analysis is examined.

\$2.19