A young couple has $30,000 (90% of their savings) to invest in either savings bonds or a real estate deal. The (zero coupon) savings bonds return $35,000 ($5,000 interest) in three years. The (completely liquid) real estate investment, after three years, is worth $120,000 if economic conditions are good (40% chance), and worth nothing ($0) if economic conditions are bad (60%). The couple decides to invest in the savings bonds.

a. What do you know about the certainty equivalent (for the couple) of the real estate investment? HINT Make sure you understand the concept of certainty equivalence.

b. What would you do in these circumstances?

c. Give me an example of a different set of probabilities that would change your decision in b.