Consider a risky portfolio. The end-of-year cash flow derived from the portfollo
ID: 1171644 • Letter: C
Question
Consider a risky portfolio. The end-of-year cash flow derived from the portfollo will be elther $130,000 or $250,000 with equal probabilities of .5. The alternative risk-free investment in T-bills pays 4% per year. a. If you require a risk premium of 5%, how much will you be willing to pay for the portfolio? (Round your answer to the nearest whole doller amount.) Price b. Suppose that the portfollo can be purchased for the amount you found In (a). What will be the expected rate of return on the portfolio? (Round your answer to the nearest whole number.) Rate of return C. Now suppose that you require a risk premium of 12%, what is the price that you will be willing to pay? (Round your answer to the nearest whole doller amount.) PriceExplanation / Answer
Expected Value after a year = [ (0.50 * 130000) + (0.50 * 250000) ]
= 65000 + 125000
= 190000
required ret = Rf + Risk Premium
= 4% + 5%
= 9%
AMount to be paid for portfolio = Ex[pected Value after a year / ( 1 +ke )
= $ 190000 / 1.09
= 174311.9
b. The expected return is 9%as it is dicounted at 9%
C: if risk premium is 12%:
Amount that can be paid = 190000 / 1.12
= 169642.9
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