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An investment of $10,000 in a high risk venture has a 50-50 chance over the next year of increasing to $14,000 or decreasing to $8000. Thus the net return can be either $4000 or -$2,000. Two investors A and B have exhibited the following indifference probabilities:
Indifference Probabilities
Net return ($) Investor A Investor B
-2000 0.00 0.00
-1000 .70 .10
0 .80 .20
1000 .85 .30
2000 .90 .50
3000 .95 .60
4000 1.00 1.00
Graph the utility functions for investors A and B and categorize each investor as either risk-averse person or a risk seeker.
Suppose you buy a 7.8 percent coupon bond today for $1,080. The bond has 5 years to maturity. What rate of return do you expect to earn on your investment? What is the annual realized yield on your investment?
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