QUESTION 1 Which of the following is true with regard to a good decision? It ens

Question

QUESTION 1

Which of the following is true with regard to a good decision?

It ensures that good outcomes will be obtained

It accounts for unlucky outcomes

It should be independent of the sequencing of uncertainties and decisions

It should incorporate all information about uncertainties and alternatives

All of these options

1 points   

QUESTION 2

Utility functions are mathematical functions that transform monetary values – payoffs and costs – into ________________.

expected values

utility values

EMV values

anchor values

None of the above

1 points   

QUESTION 3

Expected monetary value (EMV) is:

the average or expected value of the information if it was completely accurate

the weighted average of possible monetary values, weighted by their probabilities

the average or expected value of the decision if you knew what would happen ahead of time

the amount that you would lose by not picking the best alternative

a decision criterion that places an equal amount on all states of nature

1 points   

QUESTION 4

For a risk averse decision maker, the certainty equivalent is larger than the expected monetary value (EMV).

True

False

1 points   

QUESTION 5

With regard to decision making, most individuals are __________________.

risk averse

risk seekers

risk maximizers

EMV maximizers

None of these options

1 points   

QUESTION 6

A landowner in Texas is offered $200,000 for the exploration rights to oil on her land, along with a 25% royalty on the future profits if oil is discovered. The landowner is also tempted to develop the field herself, believing that the interest in her land is a good indication that oil is present. In that case, she will have to contract a local drilling company to drill an exploratory well on her own. The cost for such a well is $750,000, which is lost forever if no oil is found. If oil is discovered, however, the landowner expects to earn future profits of $7,500,000. Finally, the landowner estimates (with the help of her geologist friend) the probability of finding oil on this site to be 70%.

What should the landowner do?

She should sell the exploration rights as the EMV of selling is 1.51 million, which is higher than the EMV of developing herself.

She should develop herself as the EMV of developing is 4.5 million, which is higher than the EMV of selling.

She should develop herself as the EMV of developing is 3.75 million, which is higher than the EMV of selling.

There is not enough information to answer this question.

1 points   

QUESTION 7

Southport Mining Corporation is considering a new mining venture in Indonesia. There are two uncertainties associated with this prospect; the metallurgical properties of the ore and the net price (market price minus mining and transportation costs) of the ore in the future.

The metallurgical properties of the ore would be classified as either “high grade” or “low grade”. Southport’s geologists have estimated that there is a 70% chance that the ore will be “high grade”, and otherwise, it will be “low grade”. Depending on the net price, both ore classifications could be commercially successful.

The anticipated net prices depended on market conditions, and also on the metallurgical properties of the ore. Southport’s economists have simplified the continuous distribution of possible prices into a two-outcome discrete distribution (“high” or “low” net price) for the investment analysis. The probabilities of these net prices, and the associated outcomes (in millions of dollars), are summarized below.

Should Southport invest in the mine or not? What is their expected profit?

Southport should invest, the expected profit is 18.4.

Southport should not invest, the expected profit is -10.

Southport should invest if the price is high, the expected profit is 14.

Southport should invest, the expected profit is 9.2.

1 points   

QUESTION 8

Suppose that a decision maker’s utility as a function of her wealth, x, is given by U(x) = ln x (the natural logarithm of x).

The decision maker now has $15,000 and two possible decisions. For decision 1, she loses $1,000 for certain. For decision 2, she loses $0 with probability 0.75 and loses $4,000 with probability 0.25. Which decision maximizes the expected utility of her net wealth?

She should choose option 2. Her expected utility is 9.58.

She should choose option 2. Her expected utility is 9.54.

She should choose option 1. Her expected utility is 9.55.

She is indifferent between the two choices.

QUESTION 9

One class of “ready-made” utility functions is called exponential utility. Exponential utility has an adjustable parameter called risk tolerance. The risk tolerance parameter measures:

how much money the decision maker has to spend

the decision maker’s attitude toward risk

how much risk there is in a given decision

the probability of an unfavorable outcome

None of these options

  

QUESTION 10

If there is a 1% chance that one of the decision maker’s family heirlooms, valued at $5,500, will be stolen during the next year, what is the most that she would be willing to pay each year for an insurance policy that completely covers the potential loss of her cherished items?

327.28

65.89

0

55

a.

It ensures that good outcomes will be obtained

b.

It accounts for unlucky outcomes

c.

It should be independent of the sequencing of uncertainties and decisions

d.

It should incorporate all information about uncertainties and alternatives

e.

All of these options

Explanation / Answer

Q2.

the answer is "b"

Q3.

The answer is option "b" using the definition of EMV

Q6.

If she develops on her own, then expected return will be

7500000*0.7-750000=4500000

So, the return obtained is 4.5 million.

If she will sell her land, then the expected return is

200000+ .25*.70*200000=235000

So, the expected return is 2.35 million.

Hence the EMV is higher on developing the land on her own as compared to selling it. So, She should develop herself as the EMV of developing is 4.5 million, which is higher than the EMV of selling.

Q7.

Expected profit=0.7*20*0.8+0.7*(-10)*0.2+0.3*0.6*10+0.4*(-20)*0.3=9.2

So, Southport should invest as the expected profit is $9.2

Q8.

If she chooses decision 1 then expected net wealth,x

15000-1000=14000

E(U(x))=E(ln(14000))=9.54

If she takes decision 2, then net wealth x

15000-0*0.75-4000*0.25=14000

E(U(x))=E(ln(14000))=9.54

So,she is indifferent between two choices

Q9.

the answer is "c"

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