Self Study Questions Topic 3

Question 1

Expected utility formula

Answer 1

probability x wealth + probability x wealth

Question 2

Absolute risk aversion (ARA)

Answer 2

Question 3

fair lottery/fair gable

Answer 3

one that has expected value of zero
risk averse individual avoids

A gamble with zero expected monetary value

Question 4

test for legitimate utility function
utility function requirements for risk averse investor

Answer 4

Question 5

Relative risk aversion (RRA)

Answer 5

Question 6

What does concave utility imply?

Answer 6

Risk Aversion

Question 7

Budget constraint with borrowing/lending

Answer 7

Question 8

indifference curves in regards to utility

Answer 8

as far north east
but along an indifference curve utility doesnt change

convex (for concave up decreasing)
diminishing marginal utility in trade off between c0 and c1

Question 9

Optimal consumption condition

Answer 9

Question 10

slope of indifference curve

Answer 10

marginal rate of substitution
rate at which consumers trade of consumption today for consumption tomorrow

Question 11

marginal rate of substitution

Answer 11

Question 12

Optimal investment condition

Answer 12

Question 13

Fisher Separation Theorem

Answer 13

Investment and consumption decisions are independent under perfect capital markets

Question 14

What is the monetary risk premium π?

Answer 14

The amount a risk-averse investor pays to avoid a fair bet

Question 15

What is the PPF in intertemporal choice?

Answer 15

The production possibility frontier showing trade-off between current and future consumption

Question 16

What is bootstrapping in bond pricing?

Answer 16

A method to derive zero rates from bond prices step-by-step

Question 17

pi

Answer 17

Question 18

Quadratic utility function

Answer 18

c>0
W< b/c (bliss point)

Question 19

differentiating a logarithmic utility function

Answer 19

Question 20

differentiating a negative exponential utility function

Answer 20

Question 21

Answer 21

Question 22

Answer 22

Question 23

Answer 23

Question 24

Answer 24

Question 25

Answer 25

Question 26

production is optimised in Money market setting (now established capital markets & money market)

Answer 26

𝑀𝑅𝑃 = −(1 + 𝑟). this is when the MML is just touching the PPF

Question 27

along the MML

Answer 27

present value of income = present value of consumption

Question 28

slope of MML

Answer 28

-(1+r)

Question 29

maximum pay for insurance

Answer 29

value - certain wealth = what you pay for insurance

Question 30

E[u(W)]

Answer 30

sum of probabilities x U(w scenario)

Question 31

U(Wc)

Answer 31

level of certain wealthm

Question 32

min premium insurance company accepts

Answer 32

insured value - E[W] E[W] = probability x wealth

Question 33

Level of wealth indifferent to remaining exposed or taking insurance

Answer 33

E[U(W)] Wc -> using the E[U(W)] compare Wc (certain wealth) to W (uninsured wealth) difference greater than premium = take insurance // if less than premium = no premium(no insurance) level of wealth where indifferent if wealth below = take the insurance if wealth above means not take insurance

Question 34

sole occupation island level produce & consume

Answer 34

1. I.C as a constant 2. equate c1 for IC & PPF 3. quadratic for csquared0 discriminant set to zero just touch 4. constant for indifference curve and sub back in for c1 & c0

Question 35

introduction of MML & Level of production

Answer 35

1. c1 for PPF 2. c1 for MML = B - (1+r)c0 3. equate and discriminant = zero 4. MML sub in B for c1 5. c0 solve when discriminant = 0

Question 36

lending/borrowing to maximise utility

Answer 36

1. highest IC touching MML (IC is a constant) 2. equate c1s 3. quadratic, discriminant = 0 4. c0, c1 values 5. borrow = consumption - endowment lvl 6. repay = borrow (1+r) 7. consume = endowment - repayment