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Evaluate the two strategies adopted by financial institution to manage their risks.

Evaluate the two strategies adopted by financial institution to manage their risks.

Essentials Of Investments
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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Please could part iii) be answered

i. Consider the two risky investments below: Scenario Asset 1 Asset 2 Probability Returns Probability Returns Depression Recession 0.1 -30% 0.1 0.2 -10% 0.2 5% Normal 0.5 20% 0.5 20% Boom 0.2 50% 0.2 -5% a) What is the expected return and the standard deviation of returns to each investment? b) If the expected return on the market portfolio is 12% and the risk-free rate is 6%. What is the expected return using CAPM for the above two assets? Assume that beta of Asset 1 is 0.2 and Asset 2 is 1.4? c) Suppose that the correlation between the returns is -0.039 estimated in part a of this questions. Produce a chart showing alternative risk-return combinations from the two investments. You can start by using 0.1 and 0.9 capital allocation to investment and continue changing it by a 10% differential. ii. What is the difference between systematic and non-systematic risk? iii. Evaluate the two strategies adopted by financial institution to manage their risks.
Transcribed Image Text:i. Consider the two risky investments below: Scenario Asset 1 Asset 2 Probability Returns Probability Returns Depression Recession 0.1 -30% 0.1 0.2 -10% 0.2 5% Normal 0.5 20% 0.5 20% Boom 0.2 50% 0.2 -5% a) What is the expected return and the standard deviation of returns to each investment? b) If the expected return on the market portfolio is 12% and the risk-free rate is 6%. What is the expected return using CAPM for the above two assets? Assume that beta of Asset 1 is 0.2 and Asset 2 is 1.4? c) Suppose that the correlation between the returns is -0.039 estimated in part a of this questions. Produce a chart showing alternative risk-return combinations from the two investments. You can start by using 0.1 and 0.9 capital allocation to investment and continue changing it by a 10% differential. ii. What is the difference between systematic and non-systematic risk? iii. Evaluate the two strategies adopted by financial institution to manage their risks.
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