(Scenario: Diversification)Use Scenario: Diversification.If Morris invests half of his money in the sunglass company and half in the rain poncho company,what is his expected gain or loss? Scenario: Diversification
Morris is considering investing $10,000 in a sunglass company or a rain poncho company.If it is a rainy year and he invests only in the sunglass company,he will lose $5,000.However,if it is a rainy year and he invests only in the rain poncho company,he will earn $10,000.If it is a sunny year and he invests only in the sunglass company,he will earn $10,000;if he invests only in the rain poncho company,he will lose $5,000 in a sunny year.There is a 50% chance of a sunny year and a 50% chance of a rainy year.
A)a loss of $2,500
B)to break even
C)a gain of $2,500
D)a gain of $10,000

Question

Quizplus · Accepted Answer

If Morris invests half of his money in the sunglass company and half in the rain poncho company, his potential gains and losses would be:

- If it is a rainy year: he would earn $5,000 from the rain poncho company and lose $2,500 from the sunglass company (half of the $5,000 loss). So his total loss would be $2,500.
- If it is a sunny year: he would earn $5,000 from the sunglass company and lose $2,500 from the rain poncho company (half of the $5,000 loss). So his total gain would be $2,500.

Since there is a 50% chance of either a sunny or rainy year, we can calculate Morris's expected gain or loss by taking the average of both scenarios:

Expected gain or loss = (0.5 x $2,500) + (0.5 x (-$2,500)) = $0

Therefore, if Morris invests half of his money in each company, he should break even on average.