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Gavin Jones’s friend is planning to invest $1 million in a rock concert to be held 1 year from now. The friend figures that he will obtain $3 million revenue from his $1 million investment - unless, my goodness, it rains. If it rains, he will lose his entire investment. There is a 50% chance that it will rain the day of the concert. Gavin suggests that he buy rain insurance. He can buy one unit of insurance for $0.50, and this unit pays $1 if it rains and nothing if it does not. He may purchase as many units as he wishes, up to $3 million.
a) What is the expected rate of return on his investment if he buys u units of insurance? (The cost of insurance is in addition to his $1 million investment.)
b) What number of units will minimize the variance of his return? What is this minimum value? And what is the corresponding expected rate of return? [Hint: Before calculating a general expression for variance, think about a simple answer.]
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In this island economy, the (a) Orange Grove Owner likes only bananas and the (b) Banana Grower only likes Chocolate. Furthermore, the (c) Chocolate Maker only likes Oranges. Explain how trade between these three producers can occur. Will the Orange ..
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