ABC CorpHas a Bonus Plan in Place for Its CEO,linking Her

question 22

Multiple Choice

ABC Corp.has a bonus plan in place for its CEO,linking her pay to annual earnings.ABC will pay her $180,000 if earnings are high,$90,000 if they are normal,and $0 if they are low.Each event is estimated to have equal probability.Assume the CEO is indifferent between this bonus plan and receiving $75,000 with certainty.Which of the following is true?

• A)The CEO's expected bonus is $90,000.
• B)The CEO is not willing to give up $15,000 in expected bonuses in order to avoid the risky scheme.
• C)$85,000 is the CEO's certainty equivalent for the current bonus plan.
• D)The CEO has no clue about risk management.

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Definitions:

Marginal Probability

The probability of a single event occurring without consideration of any other events, typically found in the context of probability distributions.

V(X + Y)

The variance of the sum of two random variables, reflecting the spread or variability of their combined distribution.

Probability Distribution

A mathematical description of the likelihood of occurrence of different possible outcomes in an experiment.

Random Variable

A variable whose outcomes are determined by a random phenomenon or process.