risk+neutral

__**Risk Neutral**__

A person who is risk neutral has no preference between a plan that will lead to a certain amount of money and a riskier plan to will lead to an expected amount of money. Someone who is risk neutral will take the time to carefully weigh two options rather than making a quick decision to either avoid or embrace some measure of risk. Most people's general approach is to be either risk averse or risk lovers, but in a given situation, especially one where there is minimal risk, it is easy for the average person to be neutral to risk.

According to Samuel A. Baker at the University of South Carolina, a television game show is a great example that can help determine a person’s risk profile. For example, let’s say that a contestant on a game show wins $10,000 and is given the option of walking away with the money or playing again knowing there is a 50% chance of winning $10,000 more.

A person who has no preference between the two choices is risk neutral. This person would be satisfied with either choice. The possibility of losing the money already won is not enough of a deterrent nor is the possibility of winning enough of an enticement to lead this person to having a preference.

__**References**__

Baye, Micheal R. __Managerial Economics and Business Strategy__. 2006, pp. 438 Samuel A. Baker, copyright 1999-2001 http://hspm.sph.sc.edu/COURSES/ECON/RiskA/RiskA.html

__**Sample Test Questions**__

Tom is risk neutral and has just received a performance bonus from his manager in the amount of $500. What is Tom most likely to do with the $500?

a. Spend the $500 on raffle tickets b. Invest the $500 in a conservative and aggressive mix of mutual funds c. It cannot be determined with the information given With the information given, it cannot be determined what Tom will do with his bonus money. We know that he is risk neutral, so he doesn't have a preference between the risky raffle tickets and the safer investment in mutual funds.

An economics student who has worked extemely hard all semester has one test remaining. This student understands all of the concepts very well and doesn't need to spend a great deal of time studying for the last quiz. If there is a baseball game on during the last evening that this student has to study for the quiz, will the student study or watch the game?

a. Study, because while there isn't a great deal of risk involved in winging it on the quiz, every bit of studying will help the grade b. Watch the game and rely on the work that has been done all semester

The correct answer is a. This student is intelligent and has learned a lot during the course of the semester, but this student would prefer an A in the course to a B, so the student decides to study and watch baseball once the quiz is over.