Question

1.A young couple has $28,000 (90% of their savings) to invest in either savings bonds or a real estate deal.  The (zero coupon) savings bonds return $35,000 ($7,000 interest) in three years.  The (completely liquid) real estate investment, after three years, is worth $66,000 if economic conditions are good (70% chance), and worth nothing ($0) if economic conditions are bad (30%).  The couple decides to invest in the savings bonds.

a.     What do you know about the certainty equivalent (for the couple) of the real estate investment?   HINT – Make sure you understand the concept of certainty equivalence.

b.     What would you do in these circumstances?  

c.     Give me an example of a different set of probabilities that would change your decision in b”.

Using certinty equivilant on Excel.

Answer 1