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Consider a person with the following utility function over wealth: u(w) = ew, where e is the exponential function (approximately equal to 2.7183) and w = wealth in hundreds of thousands of dollars. Suppose that this person has;a 40% chance of wealth of $50,000 and a 60% chance of wealth of $1,000,000 as summarized by P(0.40, $50,000, $1,000,000).;a. What is the expected value of wealth?;b. Construct a graph of this utility;function.;c. Is this person risk averse, risk neutral, or;a risk seeker?;d. What is this person???s certainty equivalent;for the prospect?;-----------------------------------------------------------------------;An individual has the following utility function;u(w) = w.5 where w = wealth.;a. Using expected utility, order the following;prospects in terms of preference;from the most to the least preferred;P1(.8, 1,000, 600);P2(.7, 1,200, 600);P3(.5, 2,000, 300);b. What is the certainty equivalent for;prospect P2?;c. Without doing any calculations, would;the certainty equivalent for prospect P1;be larger or smaller? Why?;-----------------------------------------------------------------;A stock has a beta of 1.2 and the standard deviation;of its returns is 25%. The market risk;premium is 5% and the risk-free rate is 4%.;a. What is the expected return for the;stock?;b. What are the expected return and standard;deviation for a portfolio that is;equally invested in the stock and the;risk-free asset?;c. A financial analyst forecasts a return of;12% for the stock. Would you buy it?;Why or why not?

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Behavioral Finance

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