Question

Round Stic M Part II: Problems (50%). You MUST show me all details of your work. Simply giving me one number is NOT acceptable and receives 0, whether or the number you give is correct. 1. Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either $70,000 or $200,000 with equal probabilities of 5. The alterative risk-free investment in T-bills pays 6% per year. (15%) &. If you require a risk premium of 8%, how much will you be willing to pay for the portfolio? (5%) - Probollitic 70,000 5 70,000 200000 s It 08 67,814, 814 1 Olpe = 185, 186, 1852 b. Now suppose that you require a risk premium of 12%. What is the price that you will be willing to pay? (5%) 11.08 U 70,009 - It .12 - 62,500 62,500 200009 - 178,571,4286 tot c. Comparing your answer to questions a and b above, what do you conclude about the relationship between the required risk premium on a portfolio and the price at which the portfolio will sell? (5%) 2. You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 2% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 40% and 60%, respectively. X has an expected rate of return of 0.10 and variance of 0.0081, and Y has an expected rate of return of 0.06 and a variance of 0.0036. The coefficient of correlation, rho, between X and Y is 0.45. If you decide to hold a complete portfolio that has a standard deviation of expected returns, i.e., the risk or sigma, of 10% (35%) 7604 oma (8) ty0% .6016 Pxy =,45 10 0081

Answer 1

Solution:)

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Solution x or 2 ovos 10,000 *Year end Cash flow from a with an equal prob of 0.5 Folio will be 22 26% Net cash flow a 70,00 X 0.5 +20,00v Xos >35 pup + lorow 245000 Risk Damtwoofer). for current payout nalue / ideal (a) a for a risk the tolio premium of 8%, the should be... afisk reton prem a Ron-Rf. 8% = Rm-6% Rm + Requised market Rm 14% folio payout 4500 LI+17) saldeal 4500 14 39473.684 (6) Risk prem 12% Rm a 12+ 6 = 18% Folio Payout 4500 + 38135.6 c) from the above two parts we can see that as the risk premium or ultimately sm increases, the price at which the portfolio should sell should also f ou for the same the required rate increases as a resulting increasing the expected sell price