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2. Two assets P and Q have the following statistical properties: E(rp) = 10%, 0p = 10%, E(ra) = 15%, 0g = 25%. The risk-free
2. Two assets P and Q have the following statistical properties: E(rp) = 10%, 0p = 10%, E(ra) = 15%, 0g = 25%. The risk-free rate of interest (on bills) is 5%, and borrowing is not possible. An investor with preferences given by U = E(r) 102, can combine bills with either P or Q but not both. (a) Explain why this investor would never combine bills with Q unless the weight in Q were greater than one-half. Use the standard deviation-expected return diagram. (b) Consider a risk-neutral investor (A=0). Which portfolio would he prefer? Within that portfolio, what would be the share of the risk-free asset? Show your solution on the o-E(r) diagram. (c) Consider a risk-averse investor (A > 0). For which values of A would the investor combine bills with Q? 2. Two assets P and Q have the following statistical properties: E(rp) = 10%, 0p = 10%, E(ra) = 15%, 0g = 25%. The risk-free rate of interest (on bills) is 5%, and borrowing is not possible. An investor with preferences given by U = E(r) 102, can combine bills with either P or Q but not both. (a) Explain why this investor would never combine bills with Q unless the weight in Q were greater than one-half. Use the standard deviation-expected return diagram. (b) Consider a risk-neutral investor (A=0). Which portfolio would he prefer? Within that portfolio, what would be the share of the risk-free asset? Show your solution on the o-E(r) diagram. (c) Consider a risk-averse investor (A > 0). For which values of A would the investor combine bills with
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