homework5 - Mitch McMichael AEM 4230 Contemporary Topics in...

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Mitch McMichael AEM 4230 Contemporary Topics in Applied Finance Monday, November 1 st , 2010 Homework #5 1. Differentiate the following terms/concepts: a) Prospect and probability distribution - Prospect: a series of wealth outcomes, each of which is associated with a probability - Probability Distribution: b) Risk and uncertainty - Risk: a state that exists hen all possible outcomes and their associated probabilities are known - Uncertainty: a state that exists when either some possible outcomes and/or their associated probabilities are unknown. c) Utility function and expected utility Utility Function: a function that specifies the assignment of numbers to possible outcomes so that preferred choices receive higher numbers - Expected Utility: d) Risk aversion, risk seeking, and risk neutrality - Risk aversion: descriptive of a person who prefers the expected value of a prospect to the prospect itself - Risk seeking: descriptive of a person who prefers a prospect to its expected value
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