Question

5. Risk aversion Erik is an investor with $5,000 available for investment. He has the folllowing three investment possibilities from which to choose: Option Scenarios Keep the $5,000 in cash for one year 1 2 Invest in a friend's business with a 50% chance of getting $10,000 after one year and a 50% chance of getting nothing Invest in a relative's business with a 3 30% chance of getting $15,000 after one year, 20% chance of getting $2,500 after one year 50% chance of getting nothing. If Erik is indifferent about these three investment options, and he thinks that they are worth the same to him. Therefore, which of the following statements is true about Erik? He is risk-neutral. He is risk-averse He is risk-loving. None of the above.

Answer 1

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ke - Microsoft Excel (Product Activation Failed) Review File Home Insert Page Layout Formulas Data View Add-Ins E AutoSum - Cut AC Wrap Text General Calibri 11 E Copy Fill Merge & Center Insert Delete Format Paste +.0 .00 Conditional Format Cell Sort & Find & BIU % .00 0 Format Painter Clear Filter Select Formatting as Table Styles Cells Clipboard Font Alignment Number Styles Editing fc TS42 TN TO TR TS TM ТР TQ TT TU expected payoff = 42 option 1 5000 o [as it is 100% chance] standard deviation 43 44 payoff (R) EXPECTED option 2 prob 45 VARIANCE PAYOFF (P*R) P* (R-E(R)^2 46 R 5000 47 0.5 10000 12500000 0.5 48 0 0 12500000 E(R) expected payoff = 49 5000 25000000 50 VARIANCE 5000 [SQRT(VARIANCE)] 51 STANDARD DEVIATION = 52 payoff (R) EXPECTED prob 53 option 3 VARIANCE PAYOFF (P*R) p*(R-E(R))^2 54 P R 0.3 55 15000 4500 30000000 0.2 56 2500 500 1250000 57 0.5 0 0 12500000 expected payoff E(R)= 58 5000 43750000 VARIANCE 59 6614.38 [SQRT(VARIANCE)] 60 STANDARD DEVIATION = 61 port future INDEX INTL CAP BUD LEASING PV, FV, ANNUITY R CONVEXITY DGM beta clean КЕ САРМ YIELD bond portfolio KE CAPM UTILITY, SHARPE, beta DIR right SANDRINE WACC Rea II erences: AG470 120% WA 04:57 tENG 25-11-2019

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Answer 2

Answer for both is risk averse

Answer 3

a.  risk neutral - if he is indifferent about the 3 options

    risk aversion - if he is concerned about  the risk

b. risk aversion- preference towards the option with the lowest risk (0)