Question

EXERCISE #2: 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.

Risky version isn’t so risky… most in two for calculator. Do it at least once

3. a)    $50,000                                                    

                        OR

                        b)    100 coin flips each of which has a

1. 50% chance of $900    (Heads)

2. 50% chance of $300    (Tails)

EV = $

               

Briefly explain your choice: (2 points)

Answer 1

A). EV = $50,000

B). EV = (.50)(900) + (.50)(300) = 450 + 150 = $600 x 100 = $60,000

Since I would be a risk averse, I would take the safest option, which would be option A and not risk the expected value of option B. For option B you would have to flip a coin 100 times each having a 50% chance it will be heads or tails. If you look at the numbers, the average money you could make is $60,000. With that being said, it would be better if I stuck with option A which is a safer bet.