An investor faces two investment gambles. The first investment promises to offer a payoff of K4, 000 with a probability of 0.4 and K1, 500 with a probability of 0.6.

The second investment gamble promises a payoff of K6, 000 with probability 0.25 and K1, 000 with a probability of 0.75. The utility function takes the form U = ln(W), where W is the payoff,

Required:

a) What is expected utility theory? [5 MARKS]

b) Using the concept of expected value, calculate the expected utility from Investment one and two. [5 MARKS]

c) On the basis of your results in (b) above, which gamble will the individual choose? Justify your answer [5 MARKS]

d) What are actuarially fair games? [5 MA