Asked by Cheng Tso Hsieh on May 26, 2024
Verified
Harley's current wealth is $600, but there is a .25 probability that he will lose $100.Harley is risk neutral.He has an opportunity to buy insurance that would restore his $100 if he lost it.
A) Harley would be willing to pay a bit more than $25 for this insurance.
B) Harley would be willing to pay up to $25 for this insurance.
C) Since Harley is risk neutral, he wouldn't be willing to pay anything for this insurance.
D) Since Harley's utility function is not specified, we can't tell how much he would be willing to pay for this insurance.
E) Harley would not be willing to pay more than $16.66 for this insurance.
Risk Neutral
A condition or attitude where an individual or entity is indifferent to risk when making investment or economic decisions, focusing solely on potential outcomes without regard to the associated risks.
Insurance
A financial product that provides compensation or coverage against losses or damages, based on the principle of risk pooling and premiums paid by the insured parties.
Probability
A measure of the likelihood that an event will occur, expressed as a number between 0 and 1 where 1 indicates certainty.
- Recognize and delineate the traits of risk-seeking and risk-indifferent attitudes.
- Assess the determinations regarding insurance and the eagerness to allocate funds for minimizing risk.
Verified Answer
YB
YUVRAJ BHANDARIMay 27, 2024
Final Answer :
B
Explanation :
As Harley is risk-neutral, he would only be willing to pay the expected value of the insurance premium. The expected value of losing $100 with a probability of 0.25 is ($100 * 0.25) = $25. Thus, Harley would be willing to pay up to $25 for this insurance, as it would provide him with a sense of security for his $600 wealth.
Learning Objectives
- Recognize and delineate the traits of risk-seeking and risk-indifferent attitudes.
- Assess the determinations regarding insurance and the eagerness to allocate funds for minimizing risk.