1. Suppose Sara is risk averse and wants to insure her store, which is worth $120,000. There is a 25% probability that her store will burn next year. If a fire occurs, the store will be worth only $60,000. The local government assesses a property tax of $4,000 on Sara's store. If the tax is collected whether or not the store burns, how much fair insurance does Sara buy? If the tax is collected only if the store does not burn, how much fair insurance does Sara buy? Show your calculations to get credit (7 points)
2. Stock market investments are inherently risky. Consider Danny, who has heavily invested in a high-tech firm with a positive earnings outlook. However, recent reports reveal that the firm's primary technology is facing a significant threat from a competitor. If the firm manages to overcome this threat, it will achieve the anticipated profits, resulting in the expected returns on investment. Conversely, if the firm fails to address this threat, its business model will be irreparably damaged, and its stock will become worthless. Experts estimate a 60 percent chance of the threat materializing. Following this news, stock prices have plummeted. Danny, who previously had $1 million invested, now finds his investment valued at only $400,000. What does prospect theory have to say about Danny's likely reaction to the news and devaluation of the stock? What has happened to the level of risk? What is Danny's likely reference point? Is Danny likely to sell out now or hold the stock? Why? How might this explain behavior in a stock market crash?(7 points)

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