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Microeconomics - Coursework Example

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Microeconomics: Risk Premium, Deter Entry to Markets and Externalities Name Institution Microeconomics: Risk Premium, Deter Entry to Markets and Externalities Q1. Risk Premium and Mechanism to Minimize Risks Uncertainty in various outcomes of an event may make one to be a risk averse…
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Download file to see previous pages... Keeping the cash will mean there will be no gain, but one enjoys a high liquidity preference of their cash. However, the future of the market performance is oblique. In the event inflation hit the economy, the money will have greatly lost its value and one would have wished making an earlier investment on either stock or bonds could have been a better option. Investing their money in either stock or bonds is always dilemmatic. An individual is ever sure of safety of money value invested in government bonds than in corporate stock. The value of government bonds depends on the performance of GDP; it could either decrease or increase annually. Assuming a GDP of 7%, the value of the bond that year would be similar to GDP. In such cases, the stock value is always higher than that of bond by 1% or 2%. A person who decided to invest in corporate stock that year will enjoy accrued savings of their investment at either 8% or 9% while one who invested in bonds will only enjoy 7%. The difference of the two becomes the risk premium. Risky situations have a high attached risk premium. There are many mechanisms an individual can explore to minimize risk. To begin with, one can just say no. For example, uncertain luxurious investments to improve one’s status in the society can be avoided. One may have a strong desire to purchase the most coveted natural Cornflower Blue Sapphire.There are two possible outcomes: purchasing a genuine sapphire or duped with a copy. Bearing in mind that one lacks the capacity to distinguish between a genuine and a counterfeit, there are two underlying benefits of varied proportions. If one goes ahead and it is a genuine one, he becomes $ 120 rich otherwise, $10 richer. In such scenario, saying no would avert possible looming risk. Secondly, one can obtain factual information before making a decision. An investor who is interested in a particular corporate stock and lacks information or have scanty facts regarding the stock performance can inquire before putting life savings into it. Information gathered in light of the corporate stock performance in the past few years or quarters may lead one to make informed decisions. A clear indication of a possible decline in the stock value that particular period would deter one from investing because at the end of the day everyone wants to see the value of their assets rising and with great stability. When one obtains information about something whether it has monetary value or not, the decision made will ultimately avert risk associated with it. Thirdly, an individual can diversify the risk. This can be done when the two events are perfectly negatively correlated (Perloff, 2011). A perfectly negatively correlated event according to Perloff refers to an event where one of the two possible outcomes must happen with great certainty. Assuming the government wants to give the tender to either IBM or Apple to supply its various departments with computers and other accessories during the next financial year. There are two possible outcomes: a win and a loss. It is absolutely clear one company must win the tender. When an individual purchase the shares of the winning company, each share value is $50 otherwise $10. One may then decide to purchase an equal share of each company just to be at the fair edge. Assuming a purchase of 5 shares, the total ...Download file to see next pagesRead More
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