Chapter 6 - Chapter 6 Answer Key: Problem Sets: 3, 4, 5,...

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Chapter 6 – Answer Key: Problem Sets: 3, 4, 5, 10, 11, 13, 14, 15, 17, 18, & 20 CFA Problems: 1, 2, 3, 4, 5, 6, & 7 Problem Sets: 3. Assuming no change in risk tolerance, that is, an unchanged risk aversion coefficient (A), then higher perceived volatility increases the denominator of the equation for the optimal investment in the risky portfolio (Equation 6.12). The proportion invested in the risky portfolio will therefore decrease. 4. a. The expected cash flow is: (0.5 × $70,000) + (0.5 × 200,000) = $135,000 With a risk premium of 8% over the risk-free rate of 6%, the required rate of return is 14%. Therefore, the present value of the portfolio is: $135,000/1.14 = $118,421 b. If the portfolio is purchased for $118,421, and provides an expected cash inflow of $135,000, then the expected rate of return [E(r)] is derived as follows: $118,421 × [1 + E(r)] = $135,000 Therefore, E(r) = 14%. The portfolio price is set to equate the expected rate or return with the required rate of return. c. If the risk premium over T-bills is now 12%, then the required return is: 6% + 12% = 18% The present value of the portfolio is now: $135,000/1.18 = $114,407 d. For a given expected cash flow, portfolios that command greater risk premia must sell at lower prices. The extra discount from expected value is a penalty for risk. 5.
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This note was uploaded on 03/25/2011 for the course FIN 4514 taught by Professor Chen during the Spring '11 term at University of South Florida - Tampa.

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Chapter 6 - Chapter 6 Answer Key: Problem Sets: 3, 4, 5,...

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