Agapito Lottery has been diagnosed as a risk-lover. He like to play: la bolita, power ball, loto, and at the horse racetrack. Agapito faces the following scenarios:

Scenario-Decision 1

a. A sure loss of $ 100,000, or

b. To play a game with

i. 50% probability of winning $ 200,000, and

ii. 50% chance of losing $ 400,000

Scenario-Decision 2

a. A sure win of $ 100,000, or

b. To play a game with:

i. 50% probability of winning $ 400,000, and

ii.50% probability of losing $ 200,000

Note: Agapito remembers the concept of expected value covered in his Statistics course when he was a

prepa at the UPR. He thinks this metric could be useful here but is not sure how to apply it. Any

advice?

Required:

a. Base in Agapito diagnostic what he would decide in each scenario, why?

b. What would you decide, why?

c. Assume that you decide to play the game in one scenario and not in the other, in which scenario you will play the game? Why?

d. Draw a utility function (axes: risk, return) in a four-quadrant graph. (hint: there are two types of utility functions).

e. What are the implications for investment decisions of your answers above, particularly (d)?