Risk And Information - Assignment Example

of the paper: RISK AND INFORMATION By As the chairman of the Insurance Club in the University, I was tasked with the obligation of selecting a viable project among the two available projects. I and other club members were to make sure that the selected project will be the most suited to increase the revenues of the club. The suggested sources of revenues were increasing the members’ semester subscription (X) or to invest the available cash to open a bookshop within the campus (Y). On evaluating these two projects; expected value criterion was used.

The expected time period is 5 years. The table below represent the problem that lead to our decision. Project X (subscription)Project Y (bookshop)YearCash flow ($)ProbabilityExpected value ($)Cash flow ($)Probability Expected value ($)140000.1400120000.11200250000.21000100000.151500360000.4240080000.54000470000.2140060000.15900580000.180040000.14001.0A1 = 60001.0A2 =8000 The expected values were calculated using the formula A=∑Aij PjiWhere;A=expected cash flowAij=cash flow of investment in period tPji =probability of cash flowAfter critical analysis using the expected value criterion method, it was evident that project Y (8000) was best suited to increase the revenues as compared to project X (6000).

The expected return of project Y is greater than that of project X. It was therefore decided that the club should invest the cash on starting a bookshop business because it tends to benefit the club more in terms of revenue increase. I am a risk lover, that’s why I’ll opt for option Y which has high risk (high probabilities) but high returns. Factors that could change the probabilitiesRisk preference-the risk preference of an individual can cause the change in the probabilities. Risk averse individuals will always prefer low probabilities (low risk but low returns) when making decisions while risk loving individuals will go for high probabilities (high risk but high returns).

Therefore, if an individual change his/her risk preferences the probabilities will change. Risk premium- this is the difference between the expected value of returns and the sure thing such that the decision maker is indifferent between the returns and the sure thing. The higher the variance of the returns the larger the risk premium hence the higher the probability. Moral hazard- when an individual exercise less care of the outcome of the returns, then it likely that the probabilities of the returns will change.

ReferencesBergmann, B. R. (1981). The Economic Risks of Being a Housewife. American Economic Review, American Economic Association.