15 since credit card companies must charge the same

Info icon This preview shows pages 1–4. Sign up to view the full content.

View Full Document Right Arrow Icon
15. Since credit-card companies must charge the same interest rate to all borrowers, they attract more low- than high-quality borrowers (i.e., more borrowers who either do not repay their debts or repay their debts late). This leads to an adverse selection problem and forces up the interest rate charged, which increases even more the proportion of low- quality borrowers, until interest rates would have to be so high that it would not pay even for low-quality borrowers to borrow. Credit-card companies reduce the adverse selection problem that they face by sharing the credit histories of borrowers with other credit-card companies. The sharing of borrowers' credit histories by credit-card companies in order to reduce the adverse selection problem that they face gives rise to complaints of invasion of privacy. This is true, but without sharing credit histories, credit-card companies would have to charge much higher credit rates, which might be unacceptable to most borrowers.
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
b. Problems: Spreadsheet problems 1. The expected value of investment A is ($4,000)(0.2) + ($5,000)(0.3) + ($6,000)(0.3) + ($7,000)(0.2) = $800 + $1,500 + $1,800 + $1,400 = $5,500. The expected value of investment B is ($4,000)(0.3) + ($6,000)(0.4) + ($8,000)(0.3) = $1,200 + $2,400 + $2,400 = $6,000. ( a ) The standard deviation of investment A is $1,024.70. The standard deviation of investment B is $1,549.19. ( b ) Investment A is less risky than investment B because its standard deviation is smaller, but it also provides a lower expected income. ( c ) It is not clear, therefore, from the information given which investment is best. It depends on whether the lower expected income from investment A is more than balanced by its lower risk. This depends on the attitude of the individual toward risk. 2. ( a ) From the spreadsheet, the expected value of project A of 2.8 is higher than 2.7 for project B, so it is preferred. ( b ) Project B has a higher expected utility of 2.315, however, so it is preferred under this criterion. ( c ) The individual is risk averse because the utility function of profit increases at a decreasing rate or faces down so that the marginal utility of profit diminishes Froeb and McCann’s chapter 17: a. Individual problems: 17-3 Boat Insurance = $2,150 Payment Probability $25,000 1 – (0.6+0.25+.12) = 0.03 $5,000 0.12 $0 0.25 $0 0.6 Expected payment = 0.03*25,000 + 0.12*5,000 + 0.25*0 + 0.6*0 = $1,350 Expected payment + $200 profit = $1,550
Image of page 2
17-4 Hotdog Uncertainty Compute expected payoffs: Enter: 0.35(50,000)+.65(0)=$17,500 Do not enter: $15,000 You should enter the market.
Image of page 3

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 4
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

0/0 PREVIEWS LEFT
Sign up to access 24/7 study resources for your classes

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern