Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either $80,000 or $200,000, with equal probabilities of 0.5. The alternative riskless investment in T-bills pays 6%. A.) If you require a risk premium of 8%, how much will you be willing to pay for the portfolio? B.) Suppose that the portfolio can be purchased for the amount you found in (a). What will be the expected rate of return on the portfolio? C.) Now suppose that you require a risk premium of 12%. What is the price that you will be willing to pay?

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Business

Fletcher

19 May, 21:58

Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either $80,000 or $200,000, with equal probabilities of 0.5. The alternative riskless investment in T-bills pays 6%. A.) If you require a risk premium of 8%, how much will you be willing to pay for the portfolio? B.) Suppose that the portfolio can be purchased for the amount you found in (a). What will be the expected rate of return on the portfolio? C.) Now suppose that you require a risk premium of 12%. What is the price that you will be willing to pay?

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Phoenix Greene · Answer 1

A

Expected return = 0.08+0.06 = 0.14 = 14%

Expected return = 0.5*80000 + 0.5*200000 / P - 1

40000+100000/P = 1.14

P = 122,807

B)

R = 6+8 = 14%

C)

Expected return = 0.12+0.06 = 0.18 = 18%

Expected return = (0.5*80000 + 0.5*200000 / P) - 1

140000/P = 1.18

P = 118,644