8. Suppose security X achieves 20% return with half chance and -10% return with half chance. (a) What is the expected return of X? What is the risk (return volatility) of X? (b) Suppose security Y achieves 22% return with 55% chance and -8% return with 45% chance. Suppose you like return and dislike risk (just like all investors). Suppose you can only invest in one of the two securities. Which security (X or Y) would you choose, and why?

8. Suppose security X achieves 20% return with half chance and -10% return with half chance. (a) What is the expected return of X? What is the risk (return volatility) of X? (b) Suppose security Y achieves 22% return with 55% chance and -8% return with 45% chance. Suppose you like return and dislike risk (just like all investors). Suppose you can only invest in one of the two securities. Which security (X or Y) would you choose, and why?

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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You are testing the no-arbitrage principle of the APT, and you find a well-diversified portfolio with a β of 0.9 with respect to the market portfolio, M. You also have a risk-free asset, rf. Create a mimicking portfolio and show that it’s beta is also 0.9.
D3) Finance Suppose Bond A carried a higher yield than comparable Bond B because of investors’ uncertainty about the future of company B. If you were an investment manager who thought the market was overplaying these fears. In particular, if you thought that yields on Bond A would fall by 50 basis points. Which bonds would you buy or sell? Explain in words.
A) Assume that you have some shares of stock in ABC Inc. Why do we say that if you also purchase a put option on the same stock, the price paid to buy the put option is like paying an insurance premium? B) We understand standard deviation of returns as a measure of risk and rational investors would like to minimize risk. Notwithstanding this, you may have read that as the standard deviation of returns of the underlying asset increases the value of an option rises. If standard deviation is a measure of risk and investors do not particularly like it, why does it lead to an increase in an option's value?
8. Which two of the following provide useful rules to assess the degree of risk reduction (provided there is not perfectly positive correlation)? A) The smaller the number of securities, the lower the risk. B) The greater the number of securities, the lower the risk. C) The more positive the correlation the better. D) The more negative the correlation the better.
9.1 q1- How would you describe the relationship between risk and return for large portfolios of investments? Select one: a. There is no clear relationship. b. The relationship is precisely a positive linear relationship. c. The relationship approximates a positive linear relationship. d. The relationship approximates a negative linear relationship.
As risk aversion increases A. a firm's beta will increase. B. investors' required rate of return will increase. C. a firm's beta will decrease. D. investors' required rate of return will decrease.
18. If one were to plot the expected returns of assets (y axis) against the systematic risk (x-axis) and construct a frontier of investments, then the indifference curves of a risk-neutral investor would: Select one or more: a. Would be straight horizontal lines b. Would be undefined and impossible to plot on such a diagram c. Would increase in utility as you go up along the y-axis d. Would be straight vertical lines e. Coincide over top the efficient frontier boundary at all points f. Would increase in utility as you go left along the x-axis
3) The optimal risky portfolio has a Sharpe ratio of 0.8. However, one of your clients does not want to hold any oil and gas stocks in his portfolio. How would the Sharpe ratio of his optimal risky portfolio change? Please explain your answer for full credit. Focus MacBook Pro A
Which of these are true about the Security Market Line and Capital Market Line models? 1. the intercepts are the same 2. the independent variable for the Capital Market Line is beta 3, the Capital Market Line applies to portfolios only O 1 and 2 only O 2 only O 1 and 3 only O 2 and 3 only O 3 only
Describe how adding a risk-free security to modern portfolio theory allows investors to do better than the efficient frontier. Additionally, explain how might the magnitude of the market risk premium impact people's desire to buy stocks?
Q1. In a world of certainty, investors will always invest in the asset with the highest return. In the real world, investors hold a diversified portfolio of securities. Why is this the case? Q2. Theoretically, returns on stocks or assets can be negatively correlated. In the real world, however, we usually encounter only positive correlations. Why may this be the case? Q3. It is said that the key factor that determines the risk of stocks in a large portfolio is not the risk of the individual assets but the covariances of the securities in the portfolio. What does this mean?
Now suppose there is no financial intermediary to handle liquidity shocks. However, at t = 1 a market for bonds opens up and agents can trade their wealth at t = 1 for wealth at t = 2. Each bond pays 1 at t = 2 and its price is pM. Calculate the consumer's optimal investment decision IM at t = 0, the price of the bond pM, and the optimal consumption in the two states cM, cM. Compare the mutual fund and bond market allocations: are c4 and c bigger or smaller than cf and c, respectively?

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