Suppose you are risk loving and you are deciding between two investments. One has a guaranteed return of 5% while the second has a 50% chance of a 10% return and a 50% chance of a 0% return. Which investment would you choose? Why?
What will be an ideal response?
The second investment has an expected return of (0.5 × 10%) + (0.5 × 0%) = 5%. Since the two investments have the same expected return and you are risk loving, you choose the second investment risk loving investors prefer to gamble on possibly earning a higher return.
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What will be an ideal response?
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What will be an ideal response?