{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Portfolio Mathematics and Capital Allocation Solution

# Portfolio Mathematics and Capital Allocation Solution -...

This preview shows pages 1–2. Sign up to view the full content.

1 FINA 3104 Practice Problems Fall 2011 Portfolio Mathematics and Capital Allocation 1. True or False (Briefly Explain) (a) The utility indifference curves of two different risk-averse investors cannot intersect. Solution: FALSE. Different risk-averse investors can have different levels of risk aversion, and their indifference curves can intersect. (Note: The utility indifference curves of the same investor (with the same risk aversion A) cannot intersect. This is because a return-risk combination (a point in the return- risk graph) can only give one utility score. Different indifference curves correspond to different utility scores, and if they intersect that would mean a single point corresponds to more than one utility score, which cannot happen.) (b) If you invest y of your wealth in a risky asset ( y > 1), and the borrowing rate r b is higher than the riskfree rate r f , the expected return on your complete portfolio is given by E( r C ) = r b + y [E( r P ) - r b ], where r P is the return on the risky asset. Solution: TRUE. When you buy on margin you are borrowing at rate r b (equivalently, you are short selling the riskfree asset at rate r b ). The expected return on your complete portfolio is given by E( r C ) = (1-y) r b + y E( r P ) = r b + y [E( r P ) - r b ]. 2. Risk and Return for Security Portfolios Suppose you have \$100 to invest in two assets, A and B. A and B are the only assets available. A is a risky asset and B is a riskfree asset. The expected return on A is 5%, and B earns a riskfree rate of 3%. The standard deviations of returns on A and B are 10% and 0%,

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

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### Page1 / 4

Portfolio Mathematics and Capital Allocation Solution -...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online