EXERCISE #1: Assuming that you are RISK AVERSE,

For each of the following alternatives choose one of the 2 options by circling either a) or b). For each choice calculate the expected value (EV) and briefly explain the logic of your choice.

1. a)$50,000

OR

b)a single coin flip with a

i)50% chance of $90,000 (Heads)

ii)50% chance of $15,000 (Tails)

EV = $

Briefly explain your choice:

2. a)$50,000

OR

b)10 coin flips each of which has a

i)50% chance of $8,500 (Heads)

ii)50% chance of $2,000(Tails)

EV = $

Briefly explain your choice:

3. a)$50,000

OR

b)100 coin flips each of which has a

i)50% chance of $700 (Heads)

ii)50% chance of $350(Tails)

EV = $

Briefly explain your choice:

NOTE: use the binomial distribution to assess the probabilities associated with at least one (more than one is optional) of the above 6 options. (Stat Trek (see below) is an appropriate website)

https://stattrek.com/online-calculator/binomial.aspx

Binomial Calculator: Online Statistical Table

Use the Binomial Calculator to compute individual and cumulative binomial probabilities. For help in using the calculator, read theFrequently-Asked Questionsor review theSample Problems.

To learn more about the binomial distribution, go to Stat Trek'stutorial on the binomial distribution.

Enter a value in each of the first three text boxes (the unshaded boxes).

Click theCalculatebutton.

The Calculator will compute Binomial and Cumulative Probabilities.

Probability of success on a single trial

Number of trials

Number of successes (x)

Binomial Probability: P(X = 7)

Cumulative Probability: P(X < 7)

Cumulative Probability: P(X<7)

Cumulative Probability: P(X > 7)

Cumulative Probability: P(X>7)

Note that the yellow variable is the one of interest!

Review the RISK ANALYSIS EXAMPLE file in the RISK ANALYSIS module on CANVAS for a worked exercise.

EXERCISE #2:

Historically the S&P 500 Index has returned about 8% a year but returns are very uneven as recent experience has reminded us - the INDEX declined by more than 50% from its peak in 2007 and took 7 years to attain that peak level again. This year the S & P 500 Index has gained over 20% but last year it declined by over 6%.%. In contrast a typical Money Market Fund has returned about 2% a year with minimal fluctuation. Given this, evaluate the following:

a) You are considering spending several thousand dollars to purchase a common stock "S&P 500" Index Fund.Assuming that you plan to use this money as a house down payment 1 year from now, how risky would you consider this investment?Briefly discuss your perception of risk in this decision, given your objective.

Very lowVery high

risk____________________________risk

1234567

Briefly explain your decision:

b) How risky would it be if you planned to use this "S&P 500" Index Fund as the major component of your retirement funds, 40 years from now?Briefly discuss your perception of risk in this decision, given your objective.

Very lowVery high

risk____________________________risk

123456

Briefly explain your decision:

c) You are considering investing several thousand dollars in a Money Market fund.If you plan to use this money as down payment on a house 1 year from now, how risky would you consider this investment?Briefly discuss your perception of risk in this decision, given your objective.

Very lowVery high

risk____________________________risk

1234567

Briefly explain your decision:

d) How risky would it be if you planned to use the Money Market fund as the major component of your retirement fund, 40 years from now?Briefly discuss your perception of risk in this decision, given your objective!

Very lowVery high

risk____________________________risk

1234567

.

Briefly explain your decision: