Water Market is due to open in the UK. Within this framework. Environment Agency (EA) is going to provide subsidies for water use to farmers. They provide this within a two-week framework and sell the water allowance coupon in a competitive market. You, as a buyer, can either buy the coupon at week 1 for a lower price, or wait and buy it in week 2 when the price may go higher or lower depending on the market. If you buy your coupon in week 1, you would pay 400 and you will be committed to your decision. That is, if you buy in week 1 you have no chance to change the deal or receive a refund At the time of your decision, you also have an option to buy a refundable coupon for 450. However, if you change the deal in week 2. a penalty of 20 is applied. In week 2, there is a 50 per cent chance that the price will reduce to 300 and 50 per cent chance that it increases to 600. (1) Formulate (with decision options and probabilities) a decision framework for this problem. [20 marks] (11) What would be the expected cost of waiting a week and then buying the coupon? [5 marks] (111) What would be the best strategy for you to buy your coupon to minimise your expected expenditure? [15 marks] (iv) How would the market sensitivity affect your final decision in (111)? [10 marks] Water Market is due to open in the UK. Within this framework. Environment Agency (EA) is going to provide subsidies for water use to farmers. They provide this within a two-week framework and sell the water allowance coupon in a competitive market. You, as a buyer, can either buy the coupon at week 1 for a lower price, or wait and buy it in week 2 when the price may go higher or lower depending on the market. If you buy your coupon in week 1, you would pay 400 and you will be committed to your decision. That is, if you buy in week 1 you have no chance to change the deal or receive a refund At the time of your decision, you also have an option to buy a refundable coupon for 450. However, if you change the deal in week 2. a penalty of 20 is applied. In week 2, there is a 50 per cent chance that the price will reduce to 300 and 50 per cent chance that it increases to 600. (1) Formulate (with decision options and probabilities) a decision framework for this problem. [20 marks] (11) What would be the expected cost of waiting a week and then buying the coupon? [5 marks] (111) What would be the best strategy for you to buy your coupon to minimise your expected expenditure? [15 marks] (iv) How would the market sensitivity affect your final decision in (111)? [10 marks]
