a) Assume that Euro-denominated bills in Germany and pound-denominated bills in the United Kingdom offer equal yields to maturity. Both are short-term assets, and both are free of default risk. Neither offers investors a risk premium. However, a German investor who holds UK bills is subject to exchange rate risk, because the pounds earned on the UK bills eventually will be exchanged for Euros at the future exchange rate. Is the German investor engaging in speculation or gambling? Explain your answer by discussing the difference between speculation and gambling. (20 Marks) b) (i) Explain the difference between risk averse, risk neutral and risk seeking investors. (20 Marks) (ii) A portfolio has an expected rate of return of 22% and standard deviation of 32%. A short-term government security offers a safe return of 9%. Discuss whether an investor with a risk-aversion parameter A= 3.5 would prefer to invest in the short-term government security or a risky portfolio. What would be the preference of an investor with a riskaversion parameter A=1 ? (20 Marks) c) Assume that you are considering creating a new pension fund for the company where you are currently working. Following the established three factor model you have incorporated stocks of those firms that may help to improve the return of the fund. However, following a suggestion from a senior colleague, you are actively thinking of including international equities into the fund with a view to improve its performance. Explain the rationale for including international equities in the pension fund. (40 Marks)