Problem: Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either $40,000 or $135,000, with equal probabilities of 0.5. The alternative less risk investment in T-bills pays 4%.
Task1. If you need a risk premium of 10%, how much will you be willing to pay for the portfolio?
Task2. Assume the portfolio can be bought for the amount you found in (a). What will the expected rate of return on portfolio be?
Task3. Now suppose you require the risk premium of 15%. What is the price you will be prepared to pay now?