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A. Explain the meaning of the term "certainty equivalent". (2 marks)

Briefly explain the importance of financial risk management at the level of the global economy.

(8 marks)

B. Karen has received the following offers by her business partner.

Offer 1

Receive K500,000

Offer 2

Equal chances of receiving cash of either K2.3 million , K3 million or K5 million. Assume the risk adjusted rate of return is 10% and the risk free rate of return is 2%.

Required:

i. Calculate the Expected cash flow from Offer 2. (4 marks)

ii. Calculate the certainty equivalent cash flow. (4 marks)

iii. Advise Karen which option she should choose giving reasons. (2 marks)

[Total: 20 Marks]