Lin Has Wealth of $100,000 and Faces a 5% Probability

question 89

Essay

Lin has wealth of $100,000 and faces a 5% probability that she will get sick and lose $40,000.
a. What is Lin's expected wealth?
b. What is Lin's expected loss?
c. What price would Lin pay for an actuarially fair insurance policy that would reimburse her the full value of her loss?
d. Suppose that Lin's certainty equivalent is $97,000. What is Lin's risk premium?

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Definitions:

Merger Arbitrage

An investment strategy that aims to profit from the successful completion of mergers and acquisitions by trading the stocks of the companies involved.

Risk Profile

An evaluation of an individual's willingness and ability to take risks, as well as the risks associated with their investment assets.

Performance Evaluation

The assessment of how investments or portfolios have performed over time, considering factors like return, risk, and comparison to benchmarks.

Mispricing

The occurrence when the market price of a security does not accurately reflect its intrinsic or theoretical value, leading to potential buying or selling opportunities.