HW6. A person has a net asset of $1 million, including a $300,000 net equity of a house (market value of the house mortgage). Specifically, the house has a market value of $500,000 including $200,000 for the structure and $300,000 for the land (which cannot be destroyed by fire), and a mortgage of $200,000. The person plans to buy $200,000 annual fire insurance for full coverage of the house. For simplicity, assume that each year the house has a 1% probability of being totally destroyed by fire and a 4% probability of being half destroyed, and a 95% probability of no damage occurring during the year. The persons utility for money can be approximated by the quartic root of money with U($100,000,000)=100 and U($0)=0.

6a.(5 points) Draw the decision tree for the persons decision of buying or not buying the insurance.

6b.(5 points) Compute the person's utility for $200,000 and use it to determine whether the person is risk-averse or risk-preferring?

6c.(5 points) Determine the maximum annual insurance premium IP the person would be willing to pay.

6d. (5 points) What is the risk premium at the maximum IP?