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Consider a risky portfolio,CAST STUDY  solution

CASE STUDY – 1

Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either $50,000 or $150,000 with equal probabilities of .5. The alternative risk-free investment in T-bills pays 5 percent per year.

a. If you require a risk premium of 10 percent, how much will you be willing to pay for the portfolio?

b. Suppose that the portfolio can be purchased for the amount you found in.

(a). What will be the expected rate of return on the portfolio?

c. Now, suppose that you require a risk premium of 15 percent. What is the price that you will be willing to pay?

d. Comparing your answers to (a) and (c), what do you conclude about the relationship between the required risk premium on a portfolio and the price at which the portfolio will sell?

CAST STUDY  solution

CASE STUDY – 1

Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either $50,000 or $150,000 with equal probabilities of .5. The alternative risk-free investment in T-bills pays 5 percent per year.

a. If you require a risk premium of 10 percent, how much will you be willing to pay for the portfolio?

b. Suppose that the portfolio can be purchased for the amount you found in.

(a). What will be the expected rate of return on the portfolio?

c. Now, suppose that you require a risk premium of 15 percent. What is the price that you will be willing to pay?

d. Comparing your answers to (a) and (c), what do you conclude about the relationship between the required risk premium on a portfolio and the price at which the portfolio will sell?