Bill owns an export business. The expected prot from his business is $100,000 a

Question

Bill owns an export business. The expected prot from his business is $100,000 a year. For

every 1% increase in the value of the Japanese yen relative to the dollar, its prots increase by

$20,000. Bill plans to buy one of two rms. One is an import business which returns an expected

prot of $70,000. For every 1% increase in the value of the Japanese yen relative to the dollar, the

prots of this rm shrink by $5,000. The second is a safe domestic rm which is certain to yield

him $70,000 a year. The two rms cost the same. If Bill is risk averse: (explain or show work)

(a) he should buy the domestic rm.

(b) he should buy the import rm.

(c) he should buy half of each of these two rms.

(d) it doesn't matter which he buys.

(e) he should buy 80% of the domestic rm and 20% of the import rm.

Explanation / Answer

Bill owns an export business. The expected prot from his business is $100,000 a year. For

every 1% increase in the value of the Japanese yen relative to the dollar, its prots increase by

$20,000. Bill plans to buy one of two rms. One is an import business which returns an expected

prot of $70,000. For every 1% increase in the value of the Japanese yen relative to the dollar, the

prots of this rm shrink by $5,000. The second is a safe domestic rm which is certain to yield

him $70,000 a year. The two rms cost the same. If Bill is risk averse: (explain or show work)

(b) he should buy the import rm.

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