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Question: Market analysts believe that the market value of stock ABC either increases to 180 or drops down to 20, with equal probability, a year from now. No dividends will be paid to shareholders during the coming year. Assume you are an investor with utility-function U = p 1/2 where p represents your utility of the ABC stock's end-of-year market value.

(a) Given your risk-aversion; how much are you willing to pay for the stock today?

(b) Given your certainty equivalent (or reservation-price) calculated above, what is the riskpremium you are demanding in order to participate in the gamble of purchasing the ABC-stock today?

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Category:- Basic Finance
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