Question
A manager must choose one of four investment options as given below. The manager cares only about the expected value and variance of the projects.
A manager must choose one of four investment options as given below. The manager cares only about the expected value and variance of the projects.
Investments | Return with Bad Luck | Probability of Bad Luck | Return with Good Luck | Probability of Good Luck |
A | 20 | 0.7 | 120 | 0.3 |
B | 40 | 0.6 | 90 | 0.4 |
C | 10 | 0.2 | 60 | 0.8 |
D | 20 | 0.5 | 100 | 0.5 |
a) Which strategy would be chosen by a risk preferring manager? a risk neutral manager? a risk-averse manager?
b) Suppose utility is given by U = Y0.5 where Y is the return. For Investment C what is the expected utility and what is the risk premium? Draw the associated diagram showing the risk premium.
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