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The Economics of Money, Banking and Financial Markets 4th Edition by Frederic Mishkin
Edition 4ISBN: 978-0133859997The Economics of Money, Banking and Financial Markets 4th Edition by Frederic Mishkin
Edition 4ISBN: 978-0133859997 Exercise 25
Suppose you have just inherited $10,000 and are considering the following options for investing the money to maximize your return:
Option 1 : Put the money in an interest-bearing checking account that earnS₂%. The FDIC insures the account against bank failure.
Option 2 : Invest the money in a corporate bond with a stated return of 5%, although there is a 10% chance the company could go bankrupt.
Option 3 : Loan the money to one of your friend's roommates, Mike, at an agreed-upon interest rate of 8%, even though you believe there is a 7% chance that Mike will leave town without repaying you.
Option 4 : Hold the money in cash and earn zero return. ,
a. If you are risk-neutral (that is, neither seek out nor shy away from risk), which of the four options should you choose to maximize your expected return?
b. Suppose Option 3 is your only possibility. If you could pay your friend $100 to find out extra information about Mike that would indicate with certainty whether he will leave town without paying, would you pay the $100? What does this say about the value of better information regarding risk?
Option 1 : Put the money in an interest-bearing checking account that earnS₂%. The FDIC insures the account against bank failure.
Option 2 : Invest the money in a corporate bond with a stated return of 5%, although there is a 10% chance the company could go bankrupt.
Option 3 : Loan the money to one of your friend's roommates, Mike, at an agreed-upon interest rate of 8%, even though you believe there is a 7% chance that Mike will leave town without repaying you.
Option 4 : Hold the money in cash and earn zero return. ,
a. If you are risk-neutral (that is, neither seek out nor shy away from risk), which of the four options should you choose to maximize your expected return?
b. Suppose Option 3 is your only possibility. If you could pay your friend $100 to find out extra information about Mike that would indicate with certainty whether he will leave town without paying, would you pay the $100? What does this say about the value of better information regarding risk?
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The Economics of Money, Banking and Financial Markets 4th Edition by Frederic Mishkin
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