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Question - Andy, a rational investor with a utility the square root of the net payoff he receives, has the choice of investing $20,000 in either Wilson Corp or Zytec Inc. There are 2 states of nature and Andy assesses that there is an 80% probability of high future cash flows (H) and a 20% probability for the state of low future cash flows (L).
The net payoff for Wilson is $5,000 for the high state and $2,000 for the low state.
The net payoff for Zytec is $5,250 for the high state and $1,000 for the low state.
Andy obtains information from the firms' MD&A. The information system for both firms shows that if the information in the MD&A is negative, the high state will occur with a probability of 20%, and the low state with a probability of 70%. The MD&A shows positive news for Wilson and negative news for Zytec. Which firm should Andy purchase? Show calculations.
Hubbard argues that the Fed can control the Fed funds rate, but the interest rate that is important for the economy is a longer-term real rate of interest. How much control does the Fed have over this longer real rate?
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