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Betty Bat loves the Vancouver Canucks. She has followed their exploits since she was five years old and believes they will win the Stanley Cup
Betty Bat loves the Vancouver Canucks. She has followed their exploits since she was five years old and believes they will win the Stanley Cup this season. She has $1,000 savings that she has hidden under her bed. She could spend $600 of the $1,000 in making Canucks championship paraphernalia: buttons, cups pens and so on. Then, if the Canucks win, she estimates her total revenue would be $1,500. If the Canucks lose, she won’t be able to sell any of her stock. Betty figures that the Canucks
have a 0.6 chance of winning the Stanley Cup. Her utility function is given by u(M )= M .
a) Will Betty make the $600 investment into Canucks championship gadgets?
b) Calculate the certainty equivalent of Betty’s prospect.
c) Suppose that a friend offer Betty insurance. He says to Betty, “If you pay me F dollars whether or not the Canucks win, then in the event that the Canucks lose, I will pay you $1,500, the amount that you would have earned had the Canucks win the Stanley Cup. If the Canucks win, I will pay you nothing.” What is the maximum value of F that Betty is willing to pay for the insurance policy? If Betty’s friend is risk neutral, will he gain by this venture? Explain.
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