Adam Has Wealth of $40,000 as Long as His Business

question 43

Multiple Choice

Adam has wealth of $40,000 as long as his business does not burn down. However, there is a 50% probability that his business will burn down and cause a $30,000 loss, leaving him with $10,000 of wealth. Adam's utility function is given by U = W^0.5, where W is wealth. What is the maximum price that Adam would pay for full insurance that covers the potential $30,000 loss? (Hint: The maximum price equals the actuarially fair premium plus the risk premium.)

• A) $17,500
• B) $12,500
• C) $15,500
• D) $22,500

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