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Consider a risky portfolio. The end of year cash flow derived from the portfolio will either be $50 000 or $150 000, with equal probabilities of 0.5 . The alternative riskless investment in t-bills pays 5%.

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

2.Suppose the portfolio can be purchased for the amount you found in (1). What will the expected rate on the portfolio be?

3.Now suppose you require a risk premium of 15%. What is the price you will be willing to pay now?

4.Comparing your answers to (1) and (3), what do you conclude about the relationship between the required risk premium on a portfolio and the price at which the portfolio will sell?

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Solution Summary

Correlate the required risk premium on a portfolio and the price at which the portfolio will sell.

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Part 1:
Expected value of portfolio = 0.5*50000+0.5*150000=$100000
Required rate of return = risk free rate + risk premium = 5%+10%=15%
Present Value of portfolio = ...

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