Betty Bat loves the Vancouver Canucks. She has followed their exploits since she was five years old and believes they will win the Stanley Cup this season. She has $1,000 savings that she has hidden under her bed. She could spend $600 of the $1,000 in making Canucks championship paraphernalia: buttons, cups pens and so on. Then, if the Canucks win, she estimates her total revenue would be $1,500. If the Canucks lose, she won’t be able to sell any of her stock. Betty figures that the Canucks

have a 0.6 chance of winning the Stanley Cup. Her utility function is given by u(M )= M .

a) Will Betty make the $600 investment into Canucks championship gadgets?

b) Calculate the certainty equivalent of Betty’s prospect.

c) Suppose that a friend offer Betty insurance. He says to Betty, “If you pay me F dollars whether or not the Canucks win, then in the event that the Canucks lose, I will pay you $1,500, the amount that you would have earned had the Canucks win the Stanley Cup. If the Canucks win, I will pay you nothing.” What is the maximum value of F that Betty is willing to pay for the insurance policy? If Betty’s friend is risk neutral, will he gain by this venture? Explain.

Answer rating: 100% (QA)

Solution a To determine whether Betty will make the 600 investment we need to calculate the expected ... View the full answer