**Problem : **
Company A and Company B are both selling stock at $1 a share. If risk-neutral
Kenny wants to buy stock in either Company A or Company B, and he thinks that
the possible future values for Company A's stock are $0, $1, $5, and $20, with
respective probabilities of 20%, 50%, 20%, and 10%, and that the possible future
values of B's stock are $0, $1, $10, and $100, with respective probabilities of
50%, 30%, 15%, and 5%, which stock will he pick?

Company A:

EV = (0.20)(0) + (0.50)(1) + (0.20)(5) + (0.10)(20) = $3.50/share

Company B:

EV = (0.50)(0) + (0.30)(1) + (0.15)(10) + (0.05)(100) = $6.80/share

**Problem : **
Which of the following are high risk investments, and which are low risk?

Gold

Stocks in new companies

IRA's

Savings bonds

Lottery tickets

Low risk: gold, IRA's, savings bonds

**Problem : **
What is the expected value of a stock whose possible future values are $0, $1,
$10, and $60 with respective probabilities of 25%, 50%, 20%, and 5%?

**Problem : **
If the current price of a stock is $7 a share, will risk-neutral Andy buy any
stock if he believes that the possible future values are $0, $2, $5, $10, and
$50, with respective probabilities of 10%, 15%, 50%, 20%, and 5%?

EV = (0.10)(0) + (0.15)(2) + (0.50)(5) + (0.20)(10) + (0.05)(50)

EV = $7.30/share

**Problem : **
What is the maximum price that risk-neutral Tamara will be willing to pay for a
stock which she believes has possible future values of $0, $5, $10, and $200,
with respective probabilities of 50%, 25%, 24%, and 1%?

EV = $5.65 a share

Tamara believes that the stock is worth about $5.65 a share, she will not be willing to pay more than that for a share of stock. If she pays $5.65 a share, she will have an expected return of 0. If the price is lower than that, she will have positive expected returns.

Take a Study Break!