Reference no: EM13479448

1*. Maria’s house is worth 1 000 000 SEK. Her utility function is given by U = m^0,5, where m <br/>represents her wealth (the value of the house). The probability of the house burning down is <br/>0,2. A fire would reduce the house value to 300 000 SEK. <br/> <br/>a) Is Maria risk avert, risk neutral or risk loving? <br/> <br/>b) Calculate the expected value of the “lottery”, in which Maria participates. <br/> <br/>c) Calculate the utility of the expected value of the lottery. <br/> <br/>d) Calculate Maria´s expected utility of the lottery. <br/>Suppose that Maria can buy insurance that yields K SEK in case the house burns down. The <br/>insurance will cost her 0,2K SEK. <br/> <br/>e) What will Maria’s wealth be in case the house burns down? What will it be in case the <br/>house does not burn down? <br/> <br/>f) Express Maria’s expected utility of the lottery if she buys insurance. <br/> <br/>g) What value of K will Maria choose (that is, what value of K maximizes her expected <br/>utility)? <br/> <br/>h) Suppose Joseph is in the same situation as Maria, i.e., his house is worth 1 000 000 SEK. <br/>His utility function is given by U = m^0,5, where m represents her wealth (the value of the <br/>house). The probability of the house burning down is 0,2. A fire would reduce the house value <br/>to 300 000 SEK. The probability that both houses burn down at the same time is zero. Is it <br/>beneficial for Maria and Joseph to establish a mutual insurance company whereby they share <br/>losses? If that is the case, what is the general principle for that?