Asked by Jaylin Johnson on Jun 29, 2024
Verified
Domingo has total wealth of $500,000 composed of a house worth $100,000 and $400,000 in cash.He keeps the cash in a safe deposit box,so that it is completely safe.However,there is a 10% chance that his house will burn down and be worth nothing and a 90% chance that nothing will happen to it.Domingo buys insurance guaranteeing that his house will be restored to its original condition should anything happen to it.The insurance premium is $2,000.Consequently (assuming other things remain unchanged) ,his future:
A) expected wealth is $480,000.
B) wealth is $500,000 for sure.
C) expected wealth is $490,000.
D) wealth is $498,000 for sure.
Expected Wealth
The anticipated sum of money an individual or entity predicts to hold in the future, based on current assets, income sources, and investment strategies.
Insurance Premium
The amount of money an individual or business must pay for an insurance policy, typically charged monthly or annually.
Safe Deposit Box
A safe deposit box is a secure container, usually held within a bank, where individuals can store valuable items such as documents, jewelry, and securities.
- Differentiate the preferences of risk aversion and risk seeking in individuals and understand their consequences on the decision-making framework.
Verified Answer
ZK
Zybrea KnightJul 04, 2024
Final Answer :
D
Explanation :
With insurance, Domingo pays a $2,000 premium, ensuring his house is protected against the risk of fire. This means his total wealth is $500,000 (house + cash) minus the $2,000 insurance premium, equaling $498,000, with no risk of losing his house value.
Learning Objectives
- Differentiate the preferences of risk aversion and risk seeking in individuals and understand their consequences on the decision-making framework.