Essentials of Investments Chapter 2 Solutions

Essentials of Investments Chapter 2 Solutions - Essentials...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Essentials of Investments (BKM 7 th Ed.) Answers to Suggested Problems – Lecture 2 Chapter 5 : 6. #3 For each portfolio: Utility = E(r) – (½ × 4 × σ 2 ). Investment E(r) σ U 1 0.12 0.30 -0.0600 2 0.15 0.50 -0.3500 3 0.21 0.16 0.1588 4 0.24 0.21 0.1518 The portfolio with the highest utility value is #3. 7. #4 When an investor is risk neutral, A = 0, so that the portfolio with the highest utility is the portfolio with the highest expected return. This is investment #4, with 24%. 9. E(R X ) = [0.2 × (–20%)] + [0.5 × 18%] + [0.3 × 50%)] = 20% E(R Y ) = [0.2 × (–15%)] + [0.5 × 20%] + [0.3 × 10%)] = 10% 10. σ X 2 = [0.2 × (–.20 – .20) 2 ] + [0.5 × (.18 – .20) 2 ] + [0.3 × (.50 – .20) 2 ] = .0592 σ X = 24.33% σ Y = [0.2 × (–.15 – .10) 2 ] + [0.5 × (.20 – .10) 2 ] + [0.3 × (.10 – .10) 2 ] = .0175 σ Y = 13.23% 15. a. E(R P ) – R f = ½A σ P 2 = ½ × 4 × (0.20) 2 = 0.08 = 8.0% b. 0.09 = ½A σ P 2 = ½ × A × (0.20) 2 A = 0.09/( ½ × 0.04) = 4.5 c. Increased risk tolerance means decreased risk aversion (A), which results in a decline in risk premiums. 18. a) Expected cash flow: 0.5($50,000) + 0.5($150,000) = $100,000 HPR = (P 1 - P 0 )/P 0 0.15 = (100,000 - P 0 )/P 0 P 0 = $86,956.52 b) HPR = (100,000 - 86956.52)/86956.52 = 15%
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00% 0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% Standard Deviation Expected Return Risk-Free Risky Portfolio w=0.7 c) A risk-premium of 15%, leads to an expected return of 15%+5%=20%. 0.20 = (100,000 - P 0 )/P 0 P 0 = $83,333.00 d) There is an inverse relationship: price decreases as the risk premium increases. In order to earn a higher risk-premium (assuming the cash flows stay the same), you must be able to buy the security at a lower price. The investor requiring the 15% risk premium (20% HPR) is requiring a larger discount as compensation for risk. 19. a) E(R P ) = 0.3(7%) + 0.7(17%) = 14% σ P = 0.7(27%) = 18.9% b) T-Bills = 30.0% Stock A = 0.7(27%) = 18.9% (The total weight in the portfolio is 70%, and the Stock B = 0.7(33%) = 23.1% portfolio consists of 27% A, 33% B, and 40% C) Stock C = 0.7(40%) = 28.0% Total Portfolio = 100%
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 06/23/2009 for the course FIN FIN420 taught by Professor Alial-elg during the Spring '09 term at King Fahd University of Petroleum & Minerals.

Page1 / 7

Essentials of Investments Chapter 2 Solutions - Essentials...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online