In this problem we are expected to determine whether we would invest money in the stock market or invest in gold based on the return of investment. We ought to calculate the expected return on the stock market and gold using a weighted average calculation-type problem to where out which asset has the highest expected return of investment. A weighted average formula is used because we are given four possible economic states with a probability (weight) associated with each possible economic state. The weights sum to 1.0.
The expected return from market equals:
𝐸𝑚 =0.15×25+0.35×20+0.25 ⋅ 5+0.25 × (−14) = 8.5.
The expected return from gold equals:
𝐸𝑔 =0.15 × (−30) + 0.35 × (−9) + 0.25×35+0.25×50=13.6.
𝐸𝑔 > 𝐸𝑚
According to the above calculations the expected return on the stock amounts to 8.5% while the gold expected return amounts to 13.6%. Due to the higher expected return of gold of 13.5 %, we would invest in gold compared to the return stock market of 8.5%. Gold has a higher return of investment due to that it is more desired and that its value is set on an open market compared to the stock market. Gold is an a mineral that has been around longer than the stock market and it is more understood when investments are concerned. According to Davidson (2018), “ Investing in any stock requires an understanding of the nature of that business, its future prospects, and a consideration of how the business and industry is likely to do in the future.”
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References
Davidson, E. 2018. Chron. Gold return Vs. Stock Market Returns. https://smallbusiness.chron.com/gold-return-vs-stock-market-returns-1818.html
