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Jay is an economics professor who’s planning his future retirement. He knows that he lives for 2 periods and has $150 thousands in disposable income in period 1 and no wage income in period 2. He has quadratic utility U = 200c − 0.5c^2,where c is measured in thousands, and both ρ = r = 0. He is considering an investment opportunity– to purchase 1 thousand junk grade “C” Greece government debt zero-coupon bonds with a face value of $100 for only $50 each. The bonds mature at their face value in period 2. The problem is that there exists a 40% chance that Greece will default at the end of period 1, and thus he will lose his investment.
1. Should he take that opportunity?
2. For a price of $25 thousand dollars, ING offers Jay to insure his investment, which means that if Greece does default, ING will repay him his initial investment, which is $50 thousand.Should he purchase insurance?
His consumption will be;U=200c- 0.5c2U= 200- 0.5c0.5c=200C=400.Having a consumption of $400, 000 and having $150,000 in the bank to take of one’sneeds, common sense dictates that one will…
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