A person who is risk averse might accept a 50% chance of losing $100 today in exchange for a 50% chance of winning $125 in two years if the interest rate was
A)9% but not 10%
B)10% but not 11%
C)11% but not 12%
D)None of the above is correct;a risk averse person would not accept any of the above bets.

Question

Quizplus · Accepted Answer

A risk averse person values certainty and is hesitant to take on risks that have a high likelihood of loss. Therefore, they would prefer a smaller but certain outcome over a larger but uncertain outcome. In this scenario, the expected value of both options is the same - $12.50 ($125 x 50% - $100 x 50% = $12.50). However, the time value of money and the interest rate play a role. At a lower interest rate, the present value of the potential $125 in two years is higher, making the uncertainty of the outcome less appealing. At a higher interest rate, the present value of the potential $125 in two years is lower, making the uncertainty more appealing. Therefore, a risk averse person might be willing to accept the 50/50 bet at an interest rate of 11% but not at an interest rate of 10% or 12%.

A Person Who Is Risk Averse Might Accept a 50