Assume you are considering investing $10,000 in a T-bill that pays 0.06 and a risky portfolio, P,
Question:
Assume you are considering investing $10,000 in a T-bill that pays 0.06 and a risky portfolio, P, constructed with 2 risky securities, X and Y. The weights of X and Y in P are 0.70 and 0.30, respectively. X has an expected rate of return of 0.16 and standard deviation of 0.02, and Y has an expected rate of return of 0.12 and a standard deviation of 0.009. X and Y have a covariance of zero (0). You have an utility function of the form: U(R)=E(R)-A/2 sigma square .
A. What would be the dollar value of your positions in X, Y, and the T-bills, respectively, if you decide to hold a portfolio that has an expected outcome of $11480?
B. Assume that the portfolio formed initially (based on your answer in A, i.e. an expected value of 11480) is your optimal complete portfolio, what should be your risk aversion coefficient?
C. Assume that you can invest in another risky portfolio “Q” composed of 50% of X and 50% of Y. You can also invest in T-bills. What should be the proportions of X and Y in the optimal complete portfolio on the new C.A.L (formed with portfolio Q).
D. Compute the loss or gain in utility between your initial situation (portfolio formed in B) and the new situation (portfolio formed in C)? provide an explanation.
Multinational Finance Evaluating Opportunities Costs and Risks of Operations
ISBN: 978-1118270127
5th edition
Authors: Kirt C. Butler