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Economics

Consider an investor with preferences given by the utility function U = E(r) – 0.5Aσ2 and there are two portfolios with the following characteristics:

Portfolio A Portfolio B

E(r) = 0.06 σ = 0.07 E(r) = 0.10 σ = 0.17

(a) Suppose that the investor has a level of risk aversion of A = 4. Which portfolio should the investor choose?

(b) Suppose that the investor has a level of risk aversion of A = 2. Which portfolio should the investor choose? Briefly explain why your answer is different from Part (a).

(c) Suppose the investor has a level of risk aversion of A = 4. What must the return be on a risk-free asset in order for the investor to be indifferent between investing in the risk-free asset and Portfolio B?

(d) Suppose the investor has a level of risk aversion of A = 4. Calculate the risk-premium associated with Portfolio B. Assume that the risk-free rate is the same as your answer in Part(c).

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Business Economics, Economics

Category:- Business Economics
Reference No.:- M91373300

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