TABLE OF CONTENTS

Question 1 of 2

Work It Out
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You must read each slide, and complete any questions on the slide, in sequence.

You have $1,000 that you can invest. If you buy General Motors stock, then, in one year’s time: with a probability of 0.4 you will get $1,600; with a probability of 0.4 you will get $1,100; and with a probability of 0.2 you will get $800. If you put the money into the bank, in one year’s time you will get $1,100 for certain.

What is the expected value of your earnings from investing in General Motors stock?
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You have $1,000 that you can invest. If you buy General Motors stock, then, in one year’s time: with a probability of 0.4 you will get $1,600; with a probability of 0.4 you will get $1,100; and with a probability of 0.2 you will get $800. If you put the money into the bank, in one year’s time you will get $1,100 for certain.

Suppose you prefer putting your money into the bank to investing it in General Motors stock. What does that tell us about your attitude to risk?
Since getting $1,100 for certain is better for you than getting an average (but risky) $1,240, you must be risk-averse: you are willing to take lower (but certain) payoff instead of a higher (but risky) one. For further review see section, “Trading Risk.”
Since getting $1,100 for certain is better for you than getting an average (but risky) $1,240, you must be risk-averse: you are willing to take lower (but certain) payoff instead of a higher (but risky) one. For further review see section, “Trading Risk.”