Gavin Jones’s friend is planning to invest $1 million in a rock concert to be held 1 year from now. The friend figures that he will obtain $2.8 million revenue from his $1 million investment—unless it rains. If it rains, he will lose his entire investment. There is a 50% chance that it will rain the day of the concert. Gavin suggests that he buy rain insurance. He can buy one unit of insurance for $0.50, and this unit pays $1 if it rains and nothing if it does not. He may purchase as many units as he wishes, up to $2.8 million. (a) What is the expected rate of return on his investment if he buys u units of insurance? (The cost of insurance is in addition to his $1 million investment.) (b) What number of units will minimize the variance of his return? What is this minimum value? And what is the corresponding expected rate of them? [Hint: Before calculating a general expression for variance, think about a simple answer.]
Gavin Jones’s friend is planning to invest $1 million in a rock
concert to be held 1 year from now. The friend figures that he will obtain $2.8 million revenue from his $1 million investment—unless it rains. If it rains, he will lose his entire investment. There is a 50% chance that it will rain the day of the concert. Gavin suggests that he buy rain insurance. He can buy one unit of insurance for $0.50, and this unit pays $1 if it rains and nothing if it does not. He may purchase as many units as he wishes, up to $2.8 million.
(a) What is the expected
(b) What number of units will minimize the variance of his return? What is this minimum value? And what is the corresponding expected rate of them? [Hint: Before calculating a general expression for variance, think about a simple answer.]
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
