a)
To calculate: The certainty equivalent yield for stocks using the three utility functions and the conclusions about whether this person will invest $100,000 in stocks or bonds.
a)
Explanation of Solution
The individual has $100,000 to invest in stocks. There is a 50 percent chance that the stocks will yield 16 percent over the next year, and a 50 percent chance that they will yield -2 percent. That is, the probabilities are,
If the stocks yield 16%, the returns will be as follows:
And, if the stock yields -2%, the returns will be as follows:
Calculating the expected utility or certainty equivalent as follows:
For,
Certainty equivalent income
For the certainty equivalent income of $106,929, the certainty equivalent
Thus, the certainty equivalent yield for
Certainty equivalent income
For certainty equivalent income of $109,098, the certainty equivalent yield
Thus, the certainty equivalent yield for
For,
Certainty equivalent income
For the certainty equivalent income of $106,242, the certainty equivalent yield
Thus, the certainty equivalent yield for
Introduction: Stocks and bonds are certificates that are traded to generate money to start a new business, or for expanding the improving an existing business. Bonds and stocks are also called to as securities, and those buying them are called investors.
b)
To calculate the certainty equivalent yield for stocks with
b)
Explanation of Solution
For,
Certainty equivalent income
For the certainty equivalent income of $107,000, the certainty equivalent yield
Thus, the certainty equivalent yield for
This utility function yields exactly the same real return as believed by the individual.
Introduction: Stocks and bonds are certificates that are traded to generate money to start a new business, or for expanding the improving an existing business. Bonds and stocks are also called to as securities, and those buying them are called investors.
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Chapter 4 Solutions
EBK INTERMEDIATE MICROECONOMICS AND ITS
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