Anthony has $1,500 that he wishes to invest for one year. He has narrowed his choices down to one of the following two actions:

a1: Buy bonds of Crypto Ltd., a company that has a very high debt-equity ratio. These bonds pay 5.4% interest, unless Crypto defaults, in which case Anthony will receive no interest but will recover his principal ($1,500).a2: Buy Government Savings Bonds, paying 2.4% interest.

Anthony assesses his prior probability of Crypto Ltd. defaulting as 0.45, and of the savings bonds defaulting as zero. His utility for money is given by the square root of the amount of his net payoff. Anthony is a rational decision maker.

Required

a.Based on his prior probabilities, which action should Anthony take? Show your work.

b. Before making a final decision, Anthony decides he needs more information. He obtains Crypto Ltd's current financial statements and examines its times-interest-earned ratio.

This ratio can be either "HI" or "LO." Upon calculating the ratio, Anthony observes that it is HI.Based on his prior experience in bond investments, Anthony knows the following conditional probabilities:

Debt-to-Equity Ratio

LOHI

Future State

ND (No Default)0.30.7

D (Default)0.90.1

Which action should Anthony now take? Show your work (Hint: you need to use Bayes' theorem).

c. An accounting standard allows Crypto Ltd. to value its property, plant, and equipment at fair value, providing this can be done reliably. The company plans to adopt this option, since it will reduce its debt-equity ratio. Evaluate (in words only) the likely impact of this adoption on the main diagonal probabilities of the information system in part b.