Question

4. Risk aversion Erik is an investor with $5,000 available for investment. He has the following three investment possibilities from which to choose: Option Scenarios Keep the $5,000 in cash for one year. 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 30% chance of getting $15,000 after one year, 20% chance of getting $2,500 after one year, 50% chance of getting nothing,

Answer 1

First Question

The correct answer is the first option, i.e. risk averse.

This answer is clear, as among the various options available with him, he has chosen the one that is risk free. HEnce, his behavior is risk averse

Second question

The correct answer is the third option: He is risk loving.

This is because:

• He has chosen a risky option when a risk free option was available
• Among the risky options available, he has chosen the one which has higher risk (option 2 has higher probability of loosing the capital and hence higher risk)

Answer 2

The answer for both of them is - risk averse