Question

DIMINISHING MARGINAL UTILITY -

(A) The utility you receive from mney follows this chart:

DOLLARS	UTILITY
1	200
2	300
3	380
4	440
5	480

Your current government bonds pay you a return of $3 per month. You can sell them and buy a stock that has a fifty percent chance of paying $4 per month and a fifty percent chance of paying $2 per month.

Why would you not make that exchange? Why would you be even less interested in a stock that had a fifty percent change of paying $5 per month and a fifty percent chance of paying $1 per month? (PLEASE INCLUDE FORMULAS USED TO SOLVE PROBLEM FOR EXCEL).

(B) ADDING AN ASSET TO A PORTFOLIO -

Your current portfolio's cash returns over the past three years looked like this:

	YEAR 1	YEAR 2	YEAR 3	E(CF)	o
Your Portfolio CF's	100	100	100	100	0

The past three years are representative of a good year, an average year, and a bad year for you. You are considering adding one of these two equally priced assets to your portfolio:

	YEAR 1	YEAR 2	YEAR 3	E(CF)	o
New Asset 1	2	6	10	6	4
New Asset 2	10	6	2	6	4

You would be indifferent between these two assets even though they have different cash flows. Why?(PLEASE INCLUDE FORMULAS USED TO SOLVE PROBLEM FOR EXCEL).

Answer 1