2 Consider the two investments listed below with possible outcomes and probabilities: INVESTMENT (in $1000) SAFE RISKY INVESTMENT+ AMOUNT 40€ 40€ GOOD SCENARIO OUTCOME 45 80+ AVERAGE SCENARIO PROB OUTCOME 0.40 0.40€ 42° 45° BAD+ SCENARIO PROB OUTCOME 0.20€ 0.20 35€ 10€ PROB 0.40€ 0.40€ a) Suppose I have utility function U(*) = (x)². What is the expected utility from each investment? b) Which investment will I choose, if any? Show and explain your work and provide the intuition. c) What is the value of the risk premium for the SAFE investment? Show and explain your work and provide the intuition. d) What is the value of the risk premium for the RISKY investment? Show and explain your work and provide the intuition. P 13 P

2 Consider the two investments listed below with possible outcomes and probabilities: INVESTMENT (in $1000) SAFE RISKY INVESTMENT+ AMOUNT 40€ 40€ GOOD SCENARIO OUTCOME 45 80+ AVERAGE SCENARIO PROB OUTCOME 0.40 0.40€ 42° 45° BAD+ SCENARIO PROB OUTCOME 0.20€ 0.20 35€ 10€ PROB 0.40€ 0.40€ a) Suppose I have utility function U(*) = (x)². What is the expected utility from each investment? b) Which investment will I choose, if any? Show and explain your work and provide the intuition. c) What is the value of the risk premium for the SAFE investment? Show and explain your work and provide the intuition. d) What is the value of the risk premium for the RISKY investment? Show and explain your work and provide the intuition. P 13 P

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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