d) What is the value of the risk premium for the SAFE investment? Show and explain your work and provide the intuition. e) What is the value of the risk premium for the RISKY investment? Show and explain your work and provide the intuition.<

ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
Publisher:NEWNAN
Chapter1: Making Economics Decisions
Section: Chapter Questions
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Solve (d) and (e) please.

1 Consider the two investments listed below with possible outcomes and probabilities:
INVESTMENT
(in $1000)
P
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 PROB
0.20
35+
0.20
10
0.40€
0.40
a) What are the expected payoffs (E(x)) and standard deviations for each investment?
b) Suppose I have utility function U(*) = √(x). What is the expected utility from each investment?
c) Which investment will I choose, if any? Show and explain your work and provide the intuition.<
d) What is the value of the risk premium for the SAFE investment? Show and explain your work and provide
the intuition.
e) What is the value of the risk premium for the RISKY investment? Show and explain your work and provide
the intuition.<
43
A
✔
→
Transcribed Image Text:1 Consider the two investments listed below with possible outcomes and probabilities: INVESTMENT (in $1000) P 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 PROB 0.20 35+ 0.20 10 0.40€ 0.40 a) What are the expected payoffs (E(x)) and standard deviations for each investment? b) Suppose I have utility function U(*) = √(x). What is the expected utility from each investment? c) Which investment will I choose, if any? Show and explain your work and provide the intuition.< d) What is the value of the risk premium for the SAFE investment? Show and explain your work and provide the intuition. e) What is the value of the risk premium for the RISKY investment? Show and explain your work and provide the intuition.< 43 A ✔ →
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