6. Risk aversion Aa Aa Erik is an investor with $5,000 available for investment.

Question

6. Risk aversion Aa Aa Erik is an investor with $5,000 available for investment. He has the following three investment possibilities from which to choose: Option Scenarios 1 Keep the $5,000 in cash for one year. 2 Invest in a friend's business with a 50% chance of getting $10,000 after one year and a 50% chance of getting nothing. 3 Invest in a relative's business with a 30% chance of getting $ 15,000 after one year, 20% chance of getting $2,500 after one year, 50% chance of getting nothing. If Erik is indifferent about these three investment options, and he thinks that they are worth the same to hinm. Therefore, which of the following statements is true about Erik? O He is risk-neutral. O He is risk-averse He is risk-loving. O None of the above.

Explanation / Answer

Option 1: Expeceted return in year 1 = 5,000

Option 2: Expected return in year 1 = 10,000*0.5 + 0*0.5 = 5,000

Option 3: Expected return in year 1 = 15,000*0.3 + 2,500*0.2 + 0*0.5 = 5,000

1)

Risk neutral

Erik is indifferent to risk and only cares anout return. Since all three options give the same return in year 1 and erik is indifferent about the risk, erik is a risk neutral investor.

2)

Risk averse

Devin would prefer other options if he gets more return for the risk he takes. Therefore, devin is a risk averse investor and will only choose lowest riskier option if the return are same for all three options.

Related Questions

Navigate

• Browse (All)
• Browse 6
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.