David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 12 Risk and information
money in a fair gamble that gives him with probability 0.5 an income of £6 and with probability
0.5 an income of £2. Should the individual put his income into this fair gamble? Use the graph of
the total utility of income to illustrate your answer.
11 We know from many situations that people will pay to avoid risk. Name three risky products that
you choose to buy. In each case, explain the motive.
1 2 Suppose the stock exchange is expected to yield a return of 5 per cent next year, but this is risky and
could be several percentage points either side of the central forecast. You are also aware that it is
possible to hold gold as an asset and that gold is known to have a small negative beta. People buy
gold in a panic so the gold price rises when the stock market is doing badly. Today's price of gold is
£500. (a) If people are risk-neutral, what is the best estimate of next year's gold price? (b) If people
are risk-averse, what do you think is the best estimate of next year's gold price?
1 3 Essay question You run a pension fund and know that in 20 years' time you need to make a lot
of payments to people who will then have retired. Should you (a) invest in bonds that mature in 20
years' time so you know exactly how much you will then have, (b) invest in equities because
historically their average return has been greater than that of bonds in the long run, or ( c) begin
mainly in equities but switch gradually into bonds as the 20-year period elapses?
For solutions to these questions contact your lecturer.
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