Nicole Nelson has come into an inheritance from her grandparents. She is attempting to decide among several investment alternatives. The return after one year is dependent primarily on the interest rate during the next year. The rate is currently 7%, and she anticipates it will stay the same or go up or down by at most 2 points. The various investment alternatives plus their returns ($10,000s) given the interest rate changes are shown in the following table. Interest Rates Investments 5% 6% 7% 8% 9%
Money market fund 1.7 2.8 3.0 3.6 4.5
Stock growth fund 5 3 3.5 5 7.5
Bond fund 5 4 3.5 3 2
Government fund 4 3.6 3.2 2.8 2.1
Risk fund 12 7 4.2 9.3 16.7
Savings bonds 3 3 3.2 3.4 3.5
Determine the best investment using the following decision criteria.
a. Maximax
b. Maximin
c. Equal likelihood
d. Assume that Nicole, with the help of a financial newsletter and some library research, has been able to assign probabilities to each of the possible interest rates during the next year as follows:
Interest Rate 5% 6% 7% 8% 9%
Probability 0.1 0.2 0.4 0.2 0.1
Supplement 1 • Operational Decision-Making Tools: Decision Analysis 43 Using expected value, determine her best investment decision.