Suppose that the percentage annual return you obtain when you invest a
dollar in gold or the stock market is dependent on the general state of the
national economy as indicated below. For example, the probability that the
economy will be in "boom" state is 0.15. In this case, if you invest in the
stock market your return is assumed to be 25%; on the other hand if you
invest in gold when the economy is in a "boom" state your return will be
minus 30%. Likewise for the other possible states of the economy. Note that
the sum of the probabilities has to be 1–and is.
State of economy
Boom
Moderate Growth
Week Growth
No Growth
Probability
0.15
0.35
0.25
0.25
Market Return
25%
20%
5%
(-14%)
Gold Return
(-30%)
(-9%)
35%
50%
Based on the expected return, would you rather invest your money in the
stock market or in gold? Why?
