BUS 375: Homework Problem #6 This purpose of this assignment is to provide the c
ID: 1104694 • Letter: B
Question
BUS 375: Homework Problem #6 This purpose of this assignment is to provide the class an opportunity to practice using the concept of EUT. 40 points Problem: Suppose an economic agent has a utility function U = Ln (R). Assume R investment is highly successful then the agent earns $10000. If the investment is is the return on investment and utility is the natural log of investment. If the modestly successful then the agent earns $5000. Assume the probability of a highly successful outcome is Prob-0.70 and.30 for a modest outcome. 1. Answer the following questions. Show all of your work! a. Derive the expected value of the investment opportunity. b. Calculate the expected utility of the investment opportunity. c. Calculate the level of utility if expected value of the investment opportunity was guaranteed. d. Calculate the certainty equivalent level of return associated with the risky investment opportunity? Interpret your answer! e. Given your answers in (a) and (d), calculate the risk premium and RAC coefficent. f. Provide a graph highlighting your answers to questions above.Explanation / Answer
a) Expected value of investment = Prob(High success)*10000+Prob(medium success) *5000
= 0.7*10000+0.3*5000 =7000+1500 =$8500.
b) Expected utility = Prob(High success)*Ln(10000)+Prob(medium success) *Ln(5000)
Expeected Utility = 0.7*9.21+ 0.3*8.52 = 9
c) Expected utility =Ln(8500) = 9.04
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