Question

Explain, using a diagram, why a risk-averse individual, choosing between two prospects with the same expected value, prefers the prospect with the smaller spread in the out- comes.

Answer #1

People's preferences towards risk differs . Most people generally prefer the less risky situation and are called risk averse.These different preferences towards risk depend on whether the marginal utility of money diminishes or increases or remains constant for the individual.For the risk averse individual , the marginal utility of money diminishes as he has more money.If the utility of a riskless prospect is more than the expected utility from a risky prospect then the individual is risk averse and has diminishing marginal utility of wealth.In such case , the additional utility that is achieved by taking the risky prospect , is not very big to offset the loss in utility that is achieved from that prospect.

In the fig we measure money income on the X axis and utility on the Y axis.The OE curve shows the utility function of an individual who is risk averse.The slope of the total utility function decreases as the money income of the individual increases.Thus the utility function curve is concave.When money income increases from Rs 10 to 20 thousand ,his total utility increases 20 units and when money income increases from Rs 20 thousand to 30 thousand his total utility increases by 10 units. .

A risk-neutral individual _____.
A. prefers a sure return to an uncertain prospect generating the
same expected return
B. will forgo a sure return in favor of an uncertain prospect
generating the same expected return
C. is indifferent between a sure return and an uncertain
prospect generating the same expected return
D. will avoid all risky investments no matter what the
return

The shape of your utility function implies that you are
(arisk-averse or risk-friendly) individual, and,
therefore, you ((you would or would not) accept
the wager because the difference in utility between B and C is
(less than or greater than) the difference between
C and A.
Which of the following best explain why the pain of losing
$1,000 exceeds the pleasure of winning $1,000 for risk-averse
people? Check all that apply.
The utility function of a risk-averse person exhibits the...

Which two of the following five statements are correct?
Select two alternatives:
A risk-averse investor will avoid investing in stocks.
Diversification eliminates systematic risk but not
idiosyncratic risk.
The 95% confidence interval for the expected return is defined
as the Historical Average Return plus or minus three standard
errors.
The realized return is the total return we earn from dividends
and capital gains, expressed as a percentage of the initial stock
price.
While there is no clear relationship between risk...

Assume that a risk-averse investor who owns shares in Minta
Company decides to add shares of either Miller Ltd or Mistra Ltd to
create a two-security portfolio. The expected return and standard
deviation are the same for all three shares. The correlation of
returns between Minta and Miller is -0.06; while, the correlation
of returns between Minta and Mistra is +0.06.
Which of the following statements is/are true? Explain why.
(i) Portfolio risk is expected to decline more when the...

a) Assume that the risk free rate is 6.5% and that the expected
return on the market is 13%. What is the required rate of return on
a stock that has a beta of 0.6?
b) As a risk averse investor, which of the following rules would
you use when choosing between two securities A and B?
A. Choose the one with the higher return when both A and B have
the same risk
B. Choose the one with the...

Suppose that an individual is choosing how to allocate
their budget for afternoon snacks between two goods: lattes and
cookies. Lattes cost $4.00 and cookies cost $2.00. The individual
budgets $20 a week.
(a) Write down the equation for the
individual’s budget line. Plot that budget line on a graph where
lattes are on the vertical axis and cookies are on the horizontal
axis. Be sure to label the axes and intercepts. What is the slope
of the budget line?...

In the probability discussion post, you were presented with two
options:, the post is reproduced below: o “ Suppose you're offered
two chances to win money based on a simple coin flip: ▪ Option 1:
If the coin lands heads, you get $5. If it lands tails, you lose
$2. ▪ Option 2: If the coin lands heads, you get $15,000. If it
lands tails, you lose $6,000.” • The expected value of Option 1
turned out to be +$1.50,...

State the Pythagorean Identity, and (using a diagram) show why
it is true. • Explain how we use this identity to determine the
value of all trigonometric functions of an angle, knowing only the
value of one trigonometric function for that angle and the quadrant
the terminal side of the angle lies in (from standard position). •
Demonstrate with an example that it is possible to ﬁnd the values
of the other ﬁve trigonometric functions for the angle without ever...

Suppose the function u(x) = ln(x) represents your taste over
gambles using an expected utility function. Consider a gamble that
will result in a lifetime consumption of x0 with probability p, and
x1 with probability 1 – p, where x1 > x0.
(a) Are you risk averse? Explain.
(b) Write down the expected utility function.
(c) Derive your certainty equivalent of the gamble. Interpret
its meaning. Use the fact that αln(x0) + βln (x1) = ln(x0 α x1 β
)....

Assume that you are risk averse and have the following three
choices.
Expected
Value
Standard
Deviation
A
$
1,830
$
970
B
2,760
1,850
C
1,680
1,330
a. Compute the coefficient of variation for
each choice. (Round the final answers to 2 decimal
places.)
Projects
Coefficient
of variation
A
B
C
b. Which project would you select?
Project B
Project C
Project A
You are asked to evaluate the following two projects for Boring
Corporation. Use a discount rate...

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