Describe the Major Tools and Criteria for Decision Making The Probability of Rates Rising Is 0

question 21

Multiple Choice

Describe the major tools and criteria for decision making. Use the information below to answer the following question(s) . The payoff table given below lists four mortgage options: $\begin{array}{|l|l|l|l|}\hline &\text { Outcome }\\\hline \text { Probability } & {\mathbf{0 . 6}} &{\mathbf{0 . 3}} &{\mathbf{0 . 1}} \\\hline \text { Decision } & \text { Rates Rise } & \text { Rates Stable } & \text { Rates Fall } \\\hline \text { 1-year ARM } & \$ 66,645 & \$ 43,650 & \$ 38,560 \\\hline \text { 3-year ARM } & \$ 62,857 & \$ 47,698 & \$ 42,726 \\\hline \text { 5-year ARM } & \$ 55,895 & \$ 50,894 & \$ 48,134 \\\hline \text { 30-year fixed } & \$ 52,276 & \$ 52,276 & \$ 52,276 \\\hline\end{array}$ The probability of rates rising is 0.6, rates stable is 0.3, and rates falling is 0.1.
-Which of the following is considered the best expected value decision?

• A) 1-year ARM
• B) 3-year ARM
• C) 5-year ARM
• D) 30-year fixed

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Definitions:

Well-Diversified Portfolio

A collection of investments that spans various assets to minimize risk while maximizing returns.

Single Index Model

A simplified model to estimate the return of a security based on the return of the market as a whole and the security's sensitivity to the market.

Portfolio's Sigma

A statistical term that represents the standard deviation of returns of an investment portfolio, reflecting its risk.

Mean-Variance Efficient Portfolio

A portfolio construction theory that suggests the best investment portfolio is one that offers the highest expected return for a given level of risk or the lowest risk for a given level of expected return.