Draw a Process Flow Map of your preparation to leave your home, dormitory, or apartment in the morning. If you work from home, go through the process up until you enter your home office ready for work. Use a rectangle to represent process steps like brushing teeth and diamonds to represent decisions like wearing warm-weather clothes. This will be part of your submission. Think carefully about the process and the details. Your flow map should stop at leaving your residence or upon entry of your home office.
Now let’s apply this technique to data modeling. An investor has three product choices in a yearlong investment with forecast outcomes—bank account (2.1% guaranteed); a bond mutual fund (0.35 probability of a 4.5% return; 0.65 probability of 7%), and a growth mutual fund (0.25 probability of 3.5% return, 50% probability of 4.5%, and the remaining probability of 10.0%).
Draw the decision tree and calculate the expected value of the three investment choices. Choose the investment that has the maximum expected value. What is your investment choice?
What will the guaranteed return for the bank deposit have to be to change your decision in favor of the bank deposit?
Create a spreadsheet that permits you to perform the following sensitivity analysis: What must the value of the largest return (currently 7%) for the bond fund be, for the expected value of the bond fund to be equal to the expected value of the growth fund?