GROUP 4 Question 1 Peter faces two investment projects one r

GROUP: 4 Question: 1 Peter faces two investment projects: one risky, paying $200 with probability 40% or $150 with probability 60%, or a riskless project paying $160. What is the expected value on the risky project? What is the risk premium on the risky project?

Solution

Expected value risky project = $ 200 * 0.40 + $ 150 * 0.60

Expected value risky project = $ 170

The risk premium of a project is the difference between the expected outcome of a project and the certainty equivalent.

Risk premium = $ 170 - $ 160

Risk premium = $ 10