Financial Risk Management Assignment One - School of Business, BF330

This document provides a comprehensive solution to a Financial Risk Management assignment. The solution addresses key concepts including investment decision analysis using expected value and decision tree methodologies. It analyzes different investment plans (A, B, and C), calculating expected payoffs, and net expected values to determine the most feasible option. Furthermore, the assignment explores certainty equivalents, risk-adjusted rates, and expected cash flow calculations to evaluate investment opportunities. The solution also includes a risk assessment scenario involving a COVID-19 outbreak and insurance, determining whether the pricing is fair. Finally, probability calculations related to coin flips are presented, including the probability of getting specific head-tail combinations.

Answer 1
Part (i)
Plan A
40%
25000
00
40000
0
60%
80000
0
Plan b
30%
10000
00
50000
0
70%
50000
0
Plan C
No
tree

Part (ii)
Expected pay
off
Plan A
14800
00
Plan B
65000
0
Plan C 0
Part
(iii)
net expected
value
Plan A
10800
00
Plan B
15000
0
Plan C 0
Part (iv)
Decision tree shall help to analyse the situation in a better manner and take
rational decision that project A is more feasible as there is higher probablity
and expected value of earning good return. Further, there is no chance of
incurring loss or not incurring any profit

Answer 2
Option
1
Guaranteed
Inflow
Option
2
Expected cash
flow
30%
45%
25%
Expected Pay
Risk Free rate
Risk Adjusted
Rate

Ans a
The certainty equivalent is a guaranteed return that someone would accept now, rather
than taking a chance on a higher, but uncertain, return in the future. Put another way,
the certainty equivalent is the guaranteed amount of cash that a person would consider
as having the same amount of desirability as a risky asset.
Ans b
Expected cash
flow
102250
00
Guaranteed cash
flow
900000
0
Ans c
Certainty cash
flow
Expected cash
flow
898901
1
Guaranteed cash
flow
871670
7
Ans d Option 2
Answer 3
Part A
Probablity of Covid Outbreak 0.50%
Insured Pay
30000
0
Cost of Insurance 1500
Expected Insurance Pay receipt 1500
Inflation 10%
Present Value 1364

No , the pricing is not fair
Part B
Probablity of head 60%
Probablity of tail 40%
(i)
Probablity of getting three
heads 6.40%
(ii) 2 heads and 1 tail
43.20
%
(iii) At least 1 head
1 head
43.20
%
2 heads and 1 tail
43.20
%
Probablity of getting three
heads 6.40%
Total
92.80
%