Alissa Roots has inherited $50,000 from her grandmother, and is evaluating investment alternatives. One alternative, insured 12-month certificates of deposit, offers 3% interest with no risk. Her other alternatives, a growth stock and a mutual fund, are risky. Their rates of return fluctuate from year to year; there are no guarantees. Historical performances of these alternatives are presented in the following probability distributions of annual rates of return.
Growth Stock Mutual Fund
Return P(Return) Return P(Return)
-10% 0.1 -5% 0.1
0% 0.4 0% 0.3
40% 0.5 15% 0.6
Alissa has no immediate need for cash, but will need $10,000 in one year for a down payment on a house. The remainder is available for long-term investments.
Evaluate Alissa's investment alternatives. Explain the relevance of the mean and the variance of these distributions to Alissa. What advice would you give her?