Use the information below to answer the following question(s). Below are four options for an investment decision. \[\begin{array} { | l | l | l | l | } \hline \text { Decision/Event } & \text { Rates Rise } & \text { Rates Stable } & \text { Rates Fall } \\ \hline \text { Bank CD } & 0.80 & 0.80 & 0.80 \\ \hline \text { Bond fund } & - 0.75 & 0.86 & 1.50 \\ \hline \text { Index fund } & 0.00 & 0.90 & 1.20 \\ \hline \text { Growth fund } & - 0.30 & 0.70 & 1.40 \\ \hline \end{array}\] -Which of the following is the average utility for the index fund decision?

A) 1.05 B) 0.70 C) 0.60 D) 0.45 A) 1.05 B) 0.70 C) 0.60 D) 0.45

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. -What is the expected payoff of the 5-year ARM?

A) $ 17,872.90 B) $ 53,618.60 C) $ 48,805.20 D) $ 20,081.80 A) $ 17,872.90 B) $ 53,618.60 C) $ 48,805.20 D) $ 20,081.80

Use the information below to answer the following question(s). Below are four options for an investment decision. \[\begin{array} { | l | l | l | l | } \hline \text { Decision/Event } & \text { Rates Rise } & \text { Rates Stable } & \text { Rates Fall } \\ \hline \text { Bank CD } & 0.80 & 0.80 & 0.80 \\ \hline \text { Bond fund } & - 0.75 & 0.86 & 1.50 \\ \hline \text { Index fund } & 0.00 & 0.90 & 1.20 \\ \hline \text { Growth fund } & - 0.30 & 0.70 & 1.40 \\ \hline \end{array}\] -Identify the average utility for the growth fund decision.

A) 1.05 B) 0.70 C) 0.20 D) 0.60 A) 1.05 B) 0.70 C) 0.20 D) 0.60

Use the information given below to answer the following question(s). Below is a payoff table that lists three mortgage options: \[\begin{array} { | l | l | l | l | } \hline & { \text { Outcome } } \\ \hline \text { Decision } & \text { Rates Rise } & \text { Rates Stable } & \text { Rates Fall } \\ \hline \text { 2-year ARM } & \$ 66,645 & \$ 43,650 & \$ 38,560 \\ \hline \text { 5-year ARM } & \$ 62,857 & \$ 47,698 & \$ 42,726 \\ \hline \text { 25-year fixed } & \$ 52,276 & \$ 52,276 & \$ 52,276 \\ \hline \end{array}\] -What is the maximum opportunity loss incurred for the 5-year ARM?

A) $ 8,626 B) $ 13,716 C) $ 14,369 D) $ 10,581 A) $ 8,626 B) $ 13,716 C) $ 14,369 D) $ 10,581

Use the information below to answer the following question(s). Below are four options for an investment decision. \[\begin{array} { | l | l | l | l | } \hline \text { Decision/Event } & \text { Rates Rise } & \text { Rates Stable } & \text { Rates Fall } \\ \hline \text { Bank CD } & 0.80 & 0.80 & 0.80 \\ \hline \text { Bond fund } & - 0.75 & 0.86 & 1.50 \\ \hline \text { Index fund } & 0.00 & 0.90 & 1.20 \\ \hline \text { Growth fund } & - 0.30 & 0.70 & 1.40 \\ \hline \end{array}\] -Which of the following formulas is used to determine the exponential utility function?

A) U(x) = 1 + e-x/R B) U(x) = 1× ex/R C) U(x) = 1/ exR D) U(x) = 1 - e-x/R A) U(x) = 1 + e-x/R B) U(x) = 1× ex/R C) U(x) = 1/ exR D) U(x) = 1 - e-x/R

Describe the major tools and criteria for decision making. Use the information below to answer the following question(s). Below is a payoff table that lists four mortgage options: \[\begin{array} { | l | l | l | l | } \hline &{ \text { Outcome } } \\ \hline \text { Decision } & \text { Rates Rise } & \text { Rates Stable } & \text { Rates Fall } \\ \hline \text { 1-year ARM } & \$ 66,645 & \$ 43,650 & \$ 38,560 \\ \hline \text { 3-year ARM } & \$ 62,857 & \$ 47,698 & \$ 42,726 \\ \hline \text { 5-year ARM } & \$ 55,895 & \$ 50,894 & \$ 48,134 \\ \hline \text { 30-year fixed } & \$ 52,276 & \$ 52,276 & \$ 52,276 \\ \hline \end{array}\] -What is the worst payoff rate for the 5-year ARM?

A) $ 50,894 B) $ 48,134 C) $ 51,641 D) $ 55,895 A) $ 50,894 B) $ 48,134 C) $ 51,641 D) $ 55,895

Compute the expected value of perfect information. Use the below information to answer the following question(s). Below is a payoff table with three mortgage options: \[\begin{array} { | l | l | l | l | } \hline & { \text { Outcome } } \\ \hline \text { Probability } & { \mathbf { 0 . 6 } } & { \mathbf { 0 . 3 } } & { \mathbf { 0 . 1 } } \\ \hline \text { Decision } & \text { Rates Rise } & \text { Rates Stable } & \text { Rates Fall } \\ \hline \text { 1-year ARM } & \$ 66,645 & \$ 43,650 & \$ 38,560 \\ \hline \text { 3-year ARM } & \$ 62,857 & \$ 47,698 & \$ 42,726 \\ \hline \text { 30-year fixed } & \$ 52,276 & \$ 52,276 & \$ 52,276 \\ \hline \end{array}\] -What is the expected opportunity loss for the 3-year ARM?

A) $ 7,979.60 B) $ 3,959.40 C) $ 6,853.50 D) $ 8,621.40 A) $ 7,979.60 B) $ 3,959.40 C) $ 6,853.50 D) $ 8,621.40

Use the information below to answer the following question(s). Below is a payoff table that lists four mortgage options: $\begin{array}{|l|l|l|l|}\hline &\text { Outcome }\\ \hline \text { Probability } & {\mathbf{0 . 6}} &{\mathbf{0 . 3}} &{\mathbf{0 . 1}} \\ \hline \text { Decision } & \text { Rates Rise } & \text { Rates Stable } & \text { Rates Fall } \\ \hline \text { 1-year ARM } & \$ 68,246 & \$ 47,487 & \$ 36,450 \\ \hline \text { 3-year ARM } & \$ 64,897 & \$ 49,356 & \$ 44,898 \\ \hline \text { 5-year ARM } & \$ 57,240 & \$ 52,988 & \$ 50,642 \\ \hline \text { 30-year fixed } & \$ 59,720 & \$ 59,720 & \$ 59,720 \\ \hline \end{array}$ The probability of rates rising is 0.6, rates stable is 0.3, and rates falling is 0.1. Answer the following questions by creating a decision tree. -Which of the following is considered the worst expected value decision?

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

Exam 16: Decision Analysis

Use the information below to answer the following question(s) Misty Inc. launches a new range of perfumes for men and women. The probability of high consumer demand for the product is 0.6 and low consumer demand is 0.4. The probability of a favorable survey response given high consumer demand is 0.9 and the probability of a favorable survey response given low consumer demand is 0.2. -Greg is indifferent between receiving $2,000, and taking a chance at $2,500 with probability 0.7 and losing $1200 with probability 0.5. What is the expected value of this gamble?

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Question 1

Correct Answer:

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A

What are the differences between an aggressive strategy and a conservative strategy?

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Question 2

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An aggressive decision maker might seek the option that holds the promise of minimizing the potential loss. For a minimization objective, this strategy is also often called a minimin strategy, that is, the decision that minimizes the minimum payoff is chosen. Aggressive decision makers are often called speculators, particularly in financial arenas because they
increase their exposure to risk in hopes of increasing their return. A conservative decision maker, on the other hand, might take a more pessimistic attitude. Such a strategy is also known as a minimax strategy because we seek the decision that corresponds to the minimum value of the largest cost. Conservative decision makers are often called risk averse and are willing to forgo potential returns in order to reduce their exposure to risk.

Use the information below to answer the following question(s). Below is a decision tree illustrating the R&D process for a new drug. Let us assume that if market is large, payoff is lognormally distributed with a mean of $4,900 million and a standard deviation of $1,000 million; if market is medium, payoff is lognormally distributed with a mean of $2,500 million and a standard deviation of $500 million; and if market is small, payoff is normally distributed with a mean of $1,800 million and standard deviation of $200 million. Let us also assume that the cost of clinical trials is uncertain and estimates are modeled with a triangular distribution with a minimum of -$700 million, a most likely value of - $550 million, and a maximum of -$500 million. Use 10,000 trials and a random seed of 1. -What is the probability that the drug will not reach the market? [Hint: Choose the approximate value.]

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Question 3

Correct Answer:

Verified

D

Use the information below to answer the following question(s). Below are four options for an investment decision. Decision/Event Rates Rise Rates Stable Rates Fall Bank CD 0.80 0.80 0.80 Bond fund -0.75 0.86 1.50 Index fund 0.00 0.90 1.20 Growth fund -0.30 0.70 1.40 -Which of the following is the average utility for the index fund decision?

(Multiple Choice)

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Question 4

What is the expected value of sample information?

(Essay)

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Question 5

Use the information below to answer the following question(s). Below is a decision tree for the airline revenue management. Create a one-way table and answer the following questions. -The expected value of perfect information (EVPI) is equal to the .

(Multiple Choice)

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Question 6

For the average payoff strategy, the decision with the best average payoff is chosen.

(True/False)

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Question 7

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: Outcome Probability Decision Rates Rise Rates Stable Rates Fall 1-year ARM \ 66,645 \ 43,650 \ 38,560 3-year ARM \ 62,857 \ 47,698 \ 42,726 5-year ARM \ 55,895 \ 50,894 \ 48,134 30-year fixed \ 52,276 \ 52,276 \ 52,276 The probability of rates rising is 0.6, rates stable is 0.3, and rates falling is 0.1. -What is the expected payoff of the 5-year ARM?

(Multiple Choice)

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Question 8

Use the information below to answer the following question(s). Below are four options for an investment decision. Decision/Event Rates Rise Rates Stable Rates Fall Bank CD 0.80 0.80 0.80 Bond fund -0.75 0.86 1.50 Index fund 0.00 0.90 1.20 Growth fund -0.30 0.70 1.40 -Identify the average utility for the growth fund decision.

(Multiple Choice)

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Question 9

What are the three elements required to characterize decisions with uncertain consequences?

(Essay)

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Question 10

Use the information given below to answer the following question(s). Below is a payoff table that lists three mortgage options: Outcome Decision Rates Rise Rates Stable Rates Fall 2-year ARM \ 66,645 \ 43,650 \ 38,560 5-year ARM \ 62,857 \ 47,698 \ 42,726 25-year fixed \ 52,276 \ 52,276 \ 52,276 -What is the maximum opportunity loss incurred for the 5-year ARM?

(Multiple Choice)

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Question 11

Use the information below to answer the following question(s). Below are four options for an investment decision. Decision/Event Rates Rise Rates Stable Rates Fall Bank CD 0.80 0.80 0.80 Bond fund -0.75 0.86 1.50 Index fund 0.00 0.90 1.20 Growth fund -0.30 0.70 1.40 -Which of the following formulas is used to determine the exponential utility function?

(Multiple Choice)

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Question 12

The expected value of sample information (EVSI) is equal to the .

(Multiple Choice)

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Question 13

Use the information below to answer the following question(s) Misty Inc. launches a new range of perfumes for men and women. The probability of high consumer demand for the product is 0.6 and low consumer demand is 0.4. The probability of a favorable survey response given high consumer demand is 0.9 and the probability of a favorable survey response given low consumer demand is 0.2. -What is the likelihood for high demand knowing that the market report is favorable?

(Multiple Choice)

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Question 14

Use the information below to answer the following question(s). Below is a decision tree illustrating the R&D process for a new drug. Let us assume that if market is large, payoff is lognormally distributed with a mean of $4,900 million and a standard deviation of $1,000 million; if market is medium, payoff is lognormally distributed with a mean of $2,500 million and a standard deviation of $500 million; and if market is small, payoff is normally distributed with a mean of $1,800 million and standard deviation of $200 million. Let us also assume that the cost of clinical trials is uncertain and estimates are modeled with a triangular distribution with a minimum of -$700 million, a most likely value of - $550 million, and a maximum of -$500 million. Use 10,000 trials and a random seed of 1. -What is the value of mode obtained from the simulation results? [Hint: Choose the approximate value.]

(Multiple Choice)

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Question 15

Describe the major tools and criteria for decision making. Use the information below to answer the following question(s). Below is a payoff table that lists four mortgage options: Outcome Decision Rates Rise Rates Stable Rates Fall 1-year ARM \ 66,645 \ 43,650 \ 38,560 3-year ARM \ 62,857 \ 47,698 \ 42,726 5-year ARM \ 55,895 \ 50,894 \ 48,134 30-year fixed \ 52,276 \ 52,276 \ 52,276 -What is the worst payoff rate for the 5-year ARM?

(Multiple Choice)

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Question 16

Compute the expected value of perfect information. Use the below information to answer the following question(s). Below is a payoff table with three mortgage options: Outcome Probability Decision Rates Rise Rates Stable Rates Fall 1-year ARM \ 66,645 \ 43,650 \ 38,560 3-year ARM \ 62,857 \ 47,698 \ 42,726 30-year fixed \ 52,276 \ 52,276 \ 52,276 -What is the expected opportunity loss for the 3-year ARM?

(Multiple Choice)

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Question 17

Use the information below to answer the following question(s). Below is a payoff table that lists four mortgage options: Outcome Probability Decision Rates Rise Rates Stable Rates Fall 1-year ARM \ 68,246 \ 47,487 \ 36,450 3-year ARM \ 64,897 \ 49,356 \ 44,898 5-year ARM \ 57,240 \ 52,988 \ 50,642 30-year fixed \ 59,720 \ 59,720 \ 59,720 The probability of rates rising is 0.6, rates stable is 0.3, and rates falling is 0.1. Answer the following questions by creating a decision tree. -Which of the following is considered the worst expected value decision?

(Multiple Choice)

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Question 18

Use the information below to answer the following question(s). Below is a decision tree for the airline revenue management. Create a one-way table and answer the following questions. -If the probability of selling the full-fare ticket is 0.80, what is the expected value of the ticket?

(Multiple Choice)

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Question 19

Use the information below to answer the following question(s) Misty Inc. launches a new range of perfumes for men and women. The probability of high consumer demand for the product is 0.6 and low consumer demand is 0.4. The probability of a favorable survey response given high consumer demand is 0.9 and the probability of a favorable survey response given low consumer demand is 0.2. -If the marketing report is unfavorable, what is the probability of low demand?

(Multiple Choice)

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Question 20

What are the differences between an aggressive strategy and a conservative strategy?

What is the expected value of sample information?

Use the information below to answer the following question(s). Below is a decision tree for the airline revenue management. Create a one-way table and answer the following questions. -The expected value of perfect information (EVPI) is equal to the .

For the average payoff strategy, the decision with the best average payoff is chosen.

What are the three elements required to characterize decisions with uncertain consequences?

The expected value of sample information (EVSI) is equal to the .

Use the information below to answer the following question(s). Below is a decision tree for the airline revenue management. Create a one-way table and answer the following questions. -If the probability of selling the full-fare ticket is 0.80, what is the expected value of the ticket?

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