1. Please provide detailed explanations for the following concepts:

• The theory of portfolio choice
• The asset market approach to understanding behavior in financial markets
• The fisher effect in the financial markets

2. Consider a $1,000-par junk bond paying a 12% annual coupon with two years to maturity. The issuing company has a 20% chance of defaulting this year, in which case the bond would not pay anything. If the company survives the first year, paying the annual coupon payment, it then has a 25% chance of defaulting in the second year. If the company defaults in the second year, neither the final coupon payment nor par value of the bond will be paid.

• What price must investors pay for this bond to expect a 10% yield to maturity?
• At that price, what is the expected holding period rate of return and standard deviation of returns? Assume that periodic cash flows are reinvested at 10%.

3.Last month, corporations supplied $250 billion in bonds to investors, at the same time average market rate of 11.8%. This month, an additional $25 billion in bonds became available, and market rate increased to 12.2% (Par value of the bond is $1,000).

Assuming a Loanable Funds Framework for interest rates, and that the demand curve remains the same, derive a linear equation for the demand for bonds by using bonds market prices, instead of interest rates.