Suppose you have just inherited 10300 and are considering di

Suppose you have just inherited $10,300 and are considering different options for investing the money to maximize your return. If you are risk-neutral (that is, neither seek out or shy away from risk), which of the following options should you choose to maximize your expected return? O A. Invest the money in a corporate bond, with a stated return of 6%, but there is a chance of 1 1% the company could go bankrupt O B. Hold the money in cash and earn zero return. ° C. Put the money in an interest-bearing checking account, which earns 1%. The FDIC insures the account against bank failure. O D. Loan the money to one of your friends\' roommates, Mike, at an agreed upon interest rate of 7%, but you believe there is a 7% chance that Mike will leave town without repaying you. Suppose the only possibility is to loan the money to one of your friends\' roommates. If you could pay your friend $150 to find out extra information about Mike that would indicate with certainty whether he will leave town without paying or not, would you pay the $150? O A. O B. ( C. O D. Yes, it is worth it, but only if Mike stays in town and pays back the loan. No, it isn\'t worth it, because the money paid to your friend increases your costs and it cuts your expected return. Yes, it is worth it, because it increases your expected return and reduces the downside risk that the loan will default. No, it isn\'t worth it, because it doesn\'t change your expected return and keeps the downside risk at the same level. What does the previous answer say about the value of better information regarding risk? O A. A problem created by asymmetric information can\'t be solved with money. OB. Paying a small amount to improve risk assessment can be very beneficial. OC. Paying a small amount to get better information regarding risk doesn\'t bring benefits. D. Paying a small amount of money is inefficient in cases of moral hazard

Solution

1) Here, I am risk neutral so I prefer to take moderate risk. 11% chance of getting bankrupt of the company is much risky than 7% chance that Mike will leave the town without paying. So I prefer to give loan the money with 7% interest rate and with 7% risk. Option D is correct.

2) If I pay $150 to find extra information about Mike, it will be beneficial for me as it increases my expected return and reduces the risk of defaulting loan. Option C is correct.

3) I have inherited $10300. I give $150 to collect more information before giving loan which increases expected return. By giving this small amount I can also decrease the risk of default. Option B is correct.