Final answer:
An individual is considered risk-averse when their certainly equivalent for a risky prospect is less than the expected value. This shows a preference for certainty and a willingness to accept a guaranteed smaller payoff over a potentially higher, yet uncertain one. Option e is the correct answer.
Step-by-step explanation:
When an individual is considered risk-averse in the context of financial decisions and prospects, this implies they prefer certainty over the possibility of a loss. A risk-averse person's certainly equivalent for a given risky prospect is typically a value they would accept with certainty over taking a gamble with potentially higher rewards but accompanied with risk.
To understand this concept, it's important to look at the expected rate of return and risk involved in an investment. The expected rate of return refers to the average projected outcome over time, whereas risk assesses the unpredictability or variability of these returns. Investments can range from low to high risk, depending on the likelihood of achieving the expected return. Actual rate of return is the end result after the investment period, which may differ from initial projections.
Risk-averse individuals weigh the outcomes differently compared to those who are risk-neutral or risk-seeking. If the certainty equivalent is less than the expected value of a risky prospect, it indicates a propensity to avoid risk. This is because the individual would accept a guaranteed smaller payoff rather than risk obtaining less (or potentially more) than the expected value. Therefore, when faced with the question, An individual is said to be risk averse if his/her certainly equivalent for a risky prospect is: the answer is E) less than its expected value.