Question

Erik is an investor with $5,000 available for investment. He has the following three investment possibilities from which to choose: Option Scenarios 1 Keep the $5,000 in cash for one year. 2 Invest in a friend’s business with a 50% chance of getting $10,000 after one year and a 50% chance of getting nothing. 3 Invest in a relative’s business with a 30% chance of getting $15,000 after one year, 20% chance of getting $2,500 after one year, 50% chance of getting nothing. Suppose Erik cares about the risk involved in options 2 and 3, and decides to select option 1 because it has no risk. Which of the following statements would be true about Erik? He is risk-averse. He is risk-neutral. He is risk-loving. None of these descriptions is accurate. Later, while examining the same investment alternatives, Erik’s brother, Devin, clearly expressed a preference for option 1. Which of the following statements is true about Devin? He is risk-averse. He is risk-neutral. He is risk-loving. None of the above.

Answer 1

Instructions are listed below.

Step-by-step explanation:

A)

Scenarios:

1- Keep the $5,000 in cash for one year.

2- Invest in a friend’s business with a 50% chance of getting $10,000 after one year and a 50% chance of getting nothing.

3- Invest in a relative’s business with a 30% chance of getting $15,000 after one year, 20% chance of getting $2,500 after one year, 50% chance of getting nothing.

Suppose Erik cares about the risk involved in options 2 and 3 and decides to select option 1 because it has no risk.

Erik is risk-averse. He can't stand the risk of losing, so he chooses to keep everything in cash.

B) Devin is also risk-averse.