Question

a) Derive in detail the type of risk premium required
by the risk averse investor

b) Hence, determine if the above result maximizes the
risk averse investor's expected utility.

Answer #1

1) Risk averse investors are those type of investors who invest in those investments where risk is low and expected return is equal these types of investors do not prefer to risk there investments for earning higher returns

RISK PREMIUM it is return in excess of risk free rate or it is a
type of compensation given to investors who invest in risky
projects in order to earn higher return so risk averse investor
risk premium will be **LOW** as they do not prefer to
take risk.

2) utility is calculated as

where A stands for utility score given for investor more the utility score more is willingness to take risk so for risk averse investor A=0 so utility will be equal to expected return and that will be maximum

Evaluate the following statements as true or false. Provide your
reasoning:
a. A risk-averse person prefers the expected utility of income
of a risky bet to the utility of the expected income of the same
bet.
b. A risk-averse person would always take a sure $10 rather than
a 10% chance at $100.
c. A risk-averse person has an increasing marginal utility of
income (or wealth).

Risk averse investors require a positive risk premium to compen-
sate for risks they take while risk neutral investors donít.
Consider a risky portfolio. The end-of-year cash áow derived from
the portfolio will be either $42,000 with probability 0.6 or
$140,000 with probability 0.4. Your friend is risk neutral. She is
willing to pay $80,000 for this risky portfolio today.
(a) What is the risk free rate implied? Show your work.
(b) You are risk averse, you require a risk...

1. Select the correct answer. a. Stand-alone risk is the risk an
investor would face if he or she held portfolio of assets. b.
Risk-averse investors like risk and require lower rate of return as
an inducement to buy riskier securities. c. Risk premium is the
difference between the expected rate of return on a given risky
asset and that on a less risky asset. d. Capital Asset Pricing
Model is based on the proposition that any stock’s required rate...

Consider an economy consisting of two stocks (X and Y) and a
risk-free asset. Investor A maximizes his utility function by
investing 10% of his wealth in the risk-free asset, 75% in X, and
15% in Y. Investor B maximizes his utility function by investing
40% of his wealth in the risk-free asset. What fraction of his
wealth does investor B invest in X?
A.
15%
B.
60%
C.
37.5%
D.
50%

You are a risk averse investor. You are willing to add an
investment with high volatility provided the correlation
coefficient of this investment with other stocks in the portfolio
is not less than +1.
True
False
10 points
The stock A has 25% standard deviation on its expected return
and the stock B has 25% standard deviation on its expected return.
The expected return for the portfolio of these two stocks will have
a standard deviation of 25%.
True...

Assume that a risk-averse investor who owns shares in Minta
Company decides to add shares of either Miller Ltd or Mistra Ltd to
create a two-security portfolio. The expected return and standard
deviation are the same for all three shares. The correlation of
returns between Minta and Miller is -0.06; while, the correlation
of returns between Minta and Mistra is +0.06.
Which of the following statements is/are true? Explain why.
(i) Portfolio risk is expected to decline more when the...

A risk averse consumer has a car valued at $10,000. There is a
10% probability that the car will be stolen this year, in which
case the value of the car for the consumer is zero. For a premium
$y, the consumer can buy an insurance plan that would replace the
car if stolen.
The consumer has utility ? ? = ?
a) What is the maximum insurance premium $y the consumer would
be
willing to pay?
b) What is...

Suppose that everyone is risk averse and has the same utility
function and an annual income of $50, 000 but people face different
risks to health. Person A has a 20% chance of experiencing a health
shock that requires $400 in expenses while Person B has a 0.2%
chance of experiencing a health shock that requires $40, 000.
(a) Calculate Person As expected loss.
(b) Calculate Person Bs expected loss.
(c) Graphically illustrate that Person B would be willing to...

What is the default risk premium?
A.The additional yield that an investor requires for holding a
bond with some default risk.
B.The yield that an investor requires for holding a bond during
the time of a recession.
C.The return that an investment is expected to yield.
D.The theoretical rate of return of an investment with zero
risk.

Which two of the following five statements are correct?
Select two alternatives:
A risk-averse investor will avoid investing in stocks.
Diversification eliminates systematic risk but not
idiosyncratic risk.
The 95% confidence interval for the expected return is defined
as the Historical Average Return plus or minus three standard
errors.
The realized return is the total return we earn from dividends
and capital gains, expressed as a percentage of the initial stock
price.
While there is no clear relationship between risk...

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