Question

# Please solve in excel .A young couple has \$28,000 (90% of their savings) to invest in...

.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.

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.

What would you do in these circumstances?

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

 R P EV = R*P Condition Investment After 3 years Probability Expected value 28000 Option A Interest Total return Savings bond 28000 7000 35000 1 35000 Good Option B Real Estate 28000 66000 0.7 46200 Bad 28000 0 0.3 0 Total EV= Good +Bad 46200

So we see if the risk premium is R

Then 46200/(1+R)^3 = 35000

1+ R =

 1.09696

SO R = 9.696% (Certainty equivalent rate)

So in this case as the returns are higher in real estate in probabilistic terms that is a better option.

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