Suppose you won the lottery and had the option of receiving (1) $0.5 million or

Question

Suppose you won the lottery and had the option of receiving (1) $0.5 million or (2) a gamble in which you would receive $1 million if a head were flipped but zero if a tail came up.

a. What is the expected value of the gamble? Round your answer to two decimal places.


b. If you choose the sure $0.5 million. Would that indicate that you are a risk averter or a risk seeker?
-Select-risk averterrisk seekerItem 2
Suppose the payoff was actually $0.5 million - that was the only choice. You now face the choice of investing it in either a U.S. Treasury bond that will return $537,500 at the end of a year or a common stock that has a 50-50 chance of being either worthless or worth $1,150,000 at the end of the year.

c. The expected profit on the T-bond investment is $37,500. What is the expected dollar profit on the stock investment? Round your answer to two decimal places.

d. The expected rate of return on the T-bond investment is 7.5%. What is the expected rate of return on the stock investment? Round your answer to two decimal places.

Explanation / Answer

Expected returns of Gamble = 0.5(1mil) + 0.5(-500k) = $0.25mil Risk averter Expected dollar profit on stock investment = 0.5(1.15mil-0.5mil) + 0.5(0mil-0.5mil) = $0.075mil = $0.08mil (2DP) Expected rate of return on stock investment = (0.075mil/0.5mil)*100 = 15%

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