Question: Problem 3

Cameron is an investor trying to decide among the following three different investment options.

Option A:

Price today: $1000

One year from today Cameron will receive one of the following payments

$1,250 with a probability of 90%
$1,000 with a probability of 8%
$0 with a probability of 2%

Option B:

Price today: $1000

One year from today Cameron will receive one of the following payments

$4,000 with a probability of 30%
$1,000 with a probability of 50%
$0 with a probability of 20%

Option C:

Price today: $1000

One year from today Cameron will receive one of the following payments

$2,000 with a probability of 33%
$1,000 with a probability of 34%
$0 with a probability of 33%

a. What is the expected value (payment) of each of the options at the end of the year?

b. Which of the options has the highest risk? Why?

c. If Cameron is a risk neutral inventor, which option will be selected?

d. How would your answer change if Cameron is a risk averse investor?