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- 1. Write down the behavioral trap that is more likely to occur in each of the following case and Justify your answer a) While investing her money on share market, Mila filters out the information that contradicts her original idea about some particular share. b) Lee attributes successful outcomes to her own actions and bad outcomes to external factors. c) Paul continues to invest in Aqua Company’s share despite its persistent negative return. d) Sifa buys only those shares that has a consistent upward trend of returns. e) Fariha suggests her friend Samia to invest on ABC Company’s share as she foresees higher return from it. f) Sunny sells a profitable Beximco share today that earned him positive return.2 . In a principal agent problem with a risk neutral principal and a risk averse agent, correcting for moral hazard leads to inefficient risk allocation. True False1. An individual's empirical discount factor and "true" discount factor coincide when the individual is a. Risk averse only. b. Risk neutral only.
- 7. Principal-Agent II A risk-neutral principal can hire a risk-averse agent to undertake a project. There are two possible outcomes for the gross profit of the principal, TL There are also two possible effort levels that the agent can exert, e = 0 or 1; if e = 0, the probability of TH is only 1/3, but if e = 1, the probability of TH increases to 2/3. 20 and TH = 50. The agent's utility from receiving a wage wand exerting effort e is Vw – e, and the agent has a reservation utility of ū = 2. (a) Assume that effort is observable. What wage will the principal offer if she wants to induce low effort? What wage will she offer if she wants to induce high effort? What contract is optimal for the principal?4. A taproom owner is trying to determine how to structure his manager's compensation. One option he considers is a flat salary of $70,000 per year. The second option is a base salary of $30,000 plus 15% of the taproom's profit. If the manager puts a lot of effort into her job, the taproom's annual profit will be $500,000 with 75% probability and $100,000 with 25% probability. If the manager exerts only modest effort, the taproom's profit will be $500,000 with 25% probability and $100,000 with 75% probability. The manager's opportunity cost of putting a lot of effort into her job is $50,000, while her opportunity cost of exerting only modest effort is $25,000. a. Draw the game tree for the interaction between the taproom owner and the manager. Assume that the taproom owner moves first. b. What is the equilibrium outcome for this game? What kind of contract should the taproom owner offer? What level of effort will the manager choose? Explain.2 Fred and his employer both know that Fred can generate $200,000 of profit peryear for his company. After negotiations, they agree that he will earn $110,000 in annual compensation. What does this imply for the value of his outside or next best altermative?a. $0b. $5,000c. $IO,000d.$20,000
- Suppose Caroline is choosing how to allocate her portfolio between two asset classes: risk-free government bonds and a risky group of diversified stocks. The following table shows the risk and return associated with different combinations of stocks and bonds.CombinationFraction of Portfolio in Diversified StocksAverage Annual ReturnStandard Deviation of Portfolio Return (Risk)(Percent)(Percent)(Percent)A 0 1.50 0B 25 3.00 5C 50 4.50 10D 75 6.00 15E 100 7.50 20There is a relationship between the risk of Caroline's portfolio and its average annual return.Suppose Caroline currently allocates 75% of her portfolio to a diversified group of stocks and 25% of her portfolio to risk-free bonds; that is, she chooses combination D. She wants to reduce the level of risk associated with her portfolio from a standard deviation of 15 to a standard deviation of 5. In order to do so, she must do which of the following? Check all that apply. Sell some of her stocks and use the proceeds to purchase…1. Tanner is choosing between two investment options. He can invest $500 now and get (guaranteed) $550 in one year, or invest $500 now and get (guaranteed) $531.40 back later today. The risk-free rate is 3.5%. Which investment should Tanner prefer? A) $531.40 later today, since $1 today is worth more than $1 in one year. B) $550 in one year, since it is $50 more than he invested rather than $31.40 more than he invested. C) Neither - both investments have a negative NPV. D) Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today.The ability of insurance to spread risk is limited bya. risk aversion and moral hazard.b. risk aversion and adverse selection.c. moral hazard and adverse selection.d. risk aversion only
- A risk-averse investor will: a. Always accept a greater risk with a greater expected return b. Only invest in assets providing certain returns c. Sometimes accept a lower expected return if it means less ri d. Never accept lower risk if it means accepting a lower expected returnQUESTION 4 1. Tertiary markets should offer investors a higher risk-return profile because: a. There may not be a buyer willing to purchase the building from the investor b. Businesses will not locate operations to these markets c. The population lacks the demographic support to drive product demand d. Primary markets will outperform on a total return basisD3) What is the misconception of the risk-reward relationship? What is the role and the ultimate goal of the decision maker? Examples, implications.