7.1 Aman, Bo, and Celia are considering an investment opportunity such that each person’s final wealth

(the return net of the investment) will be W1 = +25 thousand with probability 0.6 or W2 = +100 thousand with probability 0.4.

a. Calculate the expected value of wealth E(W).

b. Aman’s utility function is U(W) = W, while Bo’s is U(W) = W0.5 and Celia’s is U(W) = W2.

For each person, calculate the expected utility of wealth, EU(W), the certainty equivalent wealth, CE, and the risk premium, RP. (Hint: If an individual’s utility function is, say, U = Wx, then the wealth corresponding to that utility level is W = U1/x, so the certainty equivalent wealth is CE = EU1/x.)

c. Determine each person’s attitude toward risk from his or her risk premium.