Consider an investor with utility given U = √ π where π is net cashflow (“profits”). This investor is facing a one-year investment opportunity that will have a net cashflow next year of either 50 or 150. These will happen with probability 0.2 and 0.8, respectively. Be sure to show your calculations when working out your answers to the questions below:
(a) What is the expected value of the investment?
(b) What is the maximum the investor will pay to take part in this investment? Explain why it is different from expected value of the investment (question a).
(c) What is the maximum the investor is willing to pay if the investor’s utility function instead is: U = π 1/4 (remember that √ π is the same as π 1/2 ) Explain.