An investment asset (IA) is offered by FIIR Investment Inc. to raising funding and described to deliver £18,000 with a likelihood of π (probability) in a success scenario whilst it is also possible that the investment fails leading to an undesirable outcome when investors are unable to receive any payoff. Consider that there is no alternative outcome i.e. the success and failure outcomes are the only realisations and that IA is considered to be a single investment unit which has to be purchased in whole without the possibility of shared ownership or divided into smaller proportions.

(1.1) What is the price of the IA (PIA) when π = 90%. Assume the time value of money is zero and an investor with a square-root preferences is evaluating the investment.

(1.2) Given the context in part (1.1), what is the expected return (per pound unit) associated with IA that the borrower needs to pay to the investor (rounded to two decimals)?

(1.3) Now suppose the FIIR Investment is intending on lowering the risk associated with the project (i.e. increase π) to justify lower cost of borrowing.
 Explain what should be their target success probability associated with the IA such that FIIR Investment Inc. is able to borrow the funds at exactly 4.17%?

(1.4) Suppose that, contrary to the part above, FIIR Investment Inc. is unable to improve the probability of success due to operational constraints and
will have to advertise π = 90% to the investor described in part (1.1), however FIIR Investment Inc. is able to offer a positive payoff under
the failure scenario to lower the risk. Explain how much should FIIR Investment Inc. promise to the investor under the failure scenario such that the cost of borrowing is exactly 4.17%?

Answer rating: 100% (QA)

11 The price of the IA PIA when 90 can be calculated using the squareroot preferences formula PIA EP... View the full answer