1) An investor has utility for money given by U(m) = . He has three investment opportunities: I1 pays $100 with certainty, I2 pays $120 and $80 with equal probability and I3 pays $150 and $30 with equal probability. Which one should he choose? (Hint: Calculate the expected utility of each investment)
2) Make a graph showing the three investments and their respective expected utilities.
3) Would you say this investor is risk neutral, risk loving or averse?
4) For this problem forget about I1 and consider only I2 and I3. This investor is given the possibility of paying $10 to transform I2 into a sure investment paying $100. Will he prefer I2 to I3?
5) After years of psychological therapy, this investor was able to change his utility for income to U(m) = m/3. Does he have the same preferences for the three investments you found in the first problem?