Consider the following scenario when answering the following questions:
Suppose that,in an experimental setting,100 students are presented with two situations involving risk and return.The students are first asked to choose between Gamble A and Gamble B,where:
Gamble A: The student will receive $1 million with a 100 percent probability.
Gamble B: The student will receive $1 million with an 89 percent probability,$5 million with a 10 percent probability,and $0 million (nothing)with a 1 percent probability.
The students are then asked to choose between Gamble C and Gamble D,where:
Gamble C: The student will receive $5 million with a 10 percent probability.
Gamble D: The student will receive $1 million with an 11 percent probability.
-A student who is risk neutral would choose Gamble B,which has an expected value of ________,over Gamble A,which has an expected value of ________.
A) $1.39 million; $1 million
B) $1 million; $1.42 million
C) $0.89 million; $1 million
D) $1 million; $0.89 million
E) $1.10 million; $1 million

Question

Quizplus · Accepted Answer

The expected value of Gamble B is calculated as follows: (0.89 * $1 million) + (0.10 * $5 million) + (0.01 * $0 million) = $0.89 million + $0.5 million + $0 = $1.39 million. The expected value of Gamble A is simply $1 million, as there is a 100 percent probability of receiving $1 million. Therefore, a risk-neutral student would prefer Gamble B over Gamble A due to its higher expected value.

Consider the Following Scenario When Answering the Following Questions