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What is david utility of not investing

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David has an endowment of $10,000 that he wants to invest in the stockmarket, which consist of two firms, A and B. Each firm's stock is worth $100 today, and will be worth $140 in one year with probability 1/2 or will stay at $100 with probability 1/2 . Assume that the evolution of both stocks is independent: that is, the probability that stock A rises in value does not vary or depend on what has happened to stock B, and vice-versa. Finally, assume that David's utility function is U(w)=√w , and interest rate is zero.

1. What is David's utility of not investing? (In this and the following questions, include the wealth endowment in your calcuations.

2. Calculate the expected value (EV) and David's expected utility (EU) of investing solely in stock A.

3.Calculate the expected value (EV) and David's expected utility (EU) of investing solely in stock B

4. Does David prefer investing to not investing? In which company?

5. Now suppose that David wants to diversify and invests half his money in stock A and the other half in stock B. a). What are the payoffs of this strategy and their respective probabilities? b).What is the expected value (EV) of this strategy, and David's expected utility (EU)?

Reference no: EM132488579

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