Question

dont use excel

1. An investor has a risk aversion of 4. If she wants to invest all her wealth in the stock market that has a standard deviation of 16%. What is the implied risk premium of the market? What is the market risk premium if she has a risk aversion of only 2? 2. There are two stocks: A and B, and Treasury Bill (TB). The parameters of these securities are following: Expected Return Standard Deviation Correlation with Stock A Stock A 10% 20% Stock B 15% 25% 0.2 TB 5% 0% a. If you need an expected return of 12% and you only have the access to the three securities above, what is your optimal portfolio composition? What is the standard deviation of your portfolio? b. If you need an expected return of 12% and you only have the access to the two stocks above (but no access to TB), what is your portfolio composition? What is the standard deviation of your portfolio?

solve using any equations

Answer 1

A.

Given,

risk aversion of the investor (A) = 4

standard deviation of portfolio (Sd) = 16%

Weight in the stock (W) = 1

weight of the risky portfolio formula:

W = (Rm - Rf)/A*Sd2

Rm - Rf = 1*0.04*16*16 = 10.24%

So, implied risk premium(Rm - Rf) = 10.24% (Answer)

B.

When A = 2

Implied risk premium (Rm - Rf) = 1*0.02*16*16 = 5.12% (Answer)

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