F4160A1-answers(2)

F4160A1-answers(2) - Prof. Chow Ying-Foon, Ph.D. Room 201A,...

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Prof. Chow Ying-Foon, Ph.D. Room 201A, Leung Kau Kui Building Department of Finance The Chinese University of Hong Kong 2009—2010 First Term Phone: (+852) 2609 7638 Fax: (+852) 2603 6586 Email: yfchow@cuhk.edu.hk FIN 4160 Intermediate Financial Theory Suggested Outline of Answers to Assignment 1 1. a. No capital market, so Robinson Crusoe’s problem is max U ( Y 0 ,Y 1 ) s.t. F ( Y 0 ,Y 1 )=0 . The f rst-order conditions imply Y 0 66 . 8699 and Y 1 36 . 1138 .S in c eh eb eg an with 100 dollars, we see that he has invested 100 66 . 8699 = 33 . 1301 dollars in real assets, which provides him with an average rate of return of approximately 8.5%. Note that Robinson Crusoe’s savings decision is tied directly to his investment decision – he consumes 66.8699 dollars and saves 33.1301 dollars. The decision abouthowmuchtoconsumeandsavewasmadeatthesametimeastheinvestment decision. The reason for this is simple: There are no capital markets in which Robinson Crusoe can borrow and lend, thus all the monies needed to f nance his investment must come from his own savings. b. By the Fisher Separation Theorem, Robinson Crusoe’s optimal consumption bun- dles ( C 0 ,C 1 ) arefoundonthel inew iths lope 1 . 075 that is tangent to the curve F ( Y 0 ,Y 1 )=0 .W es o l v e dY 1 /dY 0 = (1 + r ) for ( Y
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F4160A1-answers(2) - Prof. Chow Ying-Foon, Ph.D. Room 201A,...

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