Bernice in Problem 5 Has the Utility Function U(x, Y)

question 6

Multiple Choice

Bernice in Problem 5 has the utility function u(x, y) = min{x, y}, where x is the number of pairs of earrings she buys per week and y is the number of dollars per week she has left to spend on other things. (We allow the possibility that she buys fractional numbers of pairs of earrings per week.) If she originally had an income of $18 per week and was paying a price of $8 per pair of earrings, then if the price of earrings rose to $14, the compensating variation of that price change (measured in dollars per week) would be closest to

• A) $12.
• B) $25.
• C) $7.20.
• D) $24.
• E) $23.

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Definitions:

Hedge Ratio

The ratio used to determine the appropriate amount of hedging required to protect a position or portfolio from price fluctuations.

Option Smirk

A pattern on the implied volatility graph for options across different strike prices that shows asymmetric volatility, often indicating market anticipation of movement.

Black-Scholes Option

A mathematical model used to price European options and derivatives by estimating the variation over time of financial instruments.

Implied Volatility

The market's forecast of a likely movement in a security's price, often derived from the price of its options.