PoF1-Seminar-Questions-2-2018.pdf

# PoF1-Seminar-Questions-2-2018.pdf - IB2530 Principles of...

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IB2530 Principles of Finance 1 Autumn Term 2018 Seminar Questions 2: Investment under Certainty and Risk Aversion and Expected Utility Investment under Certainty All of the problems on this sheet are examinable. Attempt A2 and A3 in preparation for the seminar in Week 4. Applications A1. (a) Mrs Spendthrift currently earns £80,000, but wants to consume £150,000 now. Her income next period will be £90,000. What is the maximum amount that she can consume next period, if the riskless lending or borrowing rate is 10% per annum? (b) Mr Miserly currently earns £50,000, but wishes to consume only £35,000 now. Next period, he will earn £60,000. What is the maximum amount that he can consume next period, if the riskless lending or borrowing rate is 10% per annum? A2. An individual is worth £60,000 today. He has no income next period. He can do three things with this money: spend some of it now, save some of it for next period or invest some of it in a capital project. If he invests in the capital project, but does not lend or borrow any money today, then he will be at point B in the diagram below. (a) Calculate the rate of riskless lending or borrowing. (b) How much does the individual invest today in the capital project?

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• Winter '16
• Mrs Spendthrift, Mr Miserly

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