Consider the following two, completely separate, economies. The expected return violatility of all stocks in both economies is the same. In the first economy, all stocks move together-in good times all prices rise together and in bad times they all fall together. In the second economy, stock returns are independent –one stock increasing in price has no effect on the price of other stocks. Assuming you are risk –averse and you could choose one of the two economies in which to invest, which one would you choose explain.

I'd invest in several stocks in the second economy. I'd be taking less risk because while some stock prices may fall, others will probably rise. The first economy is like putting all of your eggs in one basket.

Ambrin Corp. expects to receive $2,000 per year for 10 years and $3,500 per year for the next 10 years. What is the present value of this 20 year cash flow? Use an 11% discount rate.

To determine which economy would be a better choice for investment, we need to consider the concept of risk diversification and how it relates to the different characteristics of each economy.

In the first economy, where all stocks move together, it implies a high level of systematic or market risk. This means that when the economy is doing well, all stocks will rise together, but during a downturn, all stocks will fall simultaneously. This lack of diversification can be risky because there is no opportunity to offset losses of one stock with gains from another. In this case, if you invest in this economy and the overall market performs poorly, you would likely experience significant losses.

In contrast, the second economy, where stock returns are independent, offers the potential for diversification. This means that the price movement of one stock does not affect the prices of other stocks. In this scenario, if you invest in different stocks across various sectors or industries, you can potentially mitigate risk by spreading your investment across different sectors. When one sector experiences a downturn, the gains from other sectors can help offset the losses, resulting in a more diversified portfolio.

Considering the concept of risk aversion, most investors typically prefer diversified portfolios that offer lower levels of risk. By spreading your investment across different stocks that are not highly correlated, you are reducing the risk of losing your entire investment due to the movement of all stocks in the same direction.

Therefore, based on the assumption that you are risk-averse, it would be more prudent to choose the second economy where stock returns are independent. This provides an opportunity to create a diversified investment portfolio that may provide a better risk-return profile compared to the first economy where stock prices move together in both good and bad times.