Working towards the profit of your investment



Consider the following situation.
i. The risk-free ratelof return for all maturities up to one year is r = 4% per year, compounded continuously. ii. You currently have $100,000 in cash.
Assume that all stocks follow the Gaussian-step random-walk model introduced in lecture. There are two stocks that you are considering as an investment.
(A) Stock A has parameters 11A = 0.20 and cA = 0.16. (B) Stock B has parameters ilB = 0.18 and cB = 0.10.
Now solve the following, showing all applicable work. (a) (2 points) In which stock do you invest your $100,000 if you want to maximize the value of your investment after a year has passed, and why?
(b) (2 points) What is the present value of the expected profit of your investment in part (a)? That is how much more do you expect to earn than what you would have achieved by investing $100,00 at the risk-free rate.

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