Economics that passes judgment, or provides advice on policy actions is called...

a) ...positive economics

b) ...negative economics

c) ...normative economics

d) ...descriptive economics

Let: R(t) = gross real yield on an irredeemable index linked gilt at the end of year t K(() = force of dividend growth during year f Y(1) = equity dividend yield at end of year t D(() = cumulative dividend index at end of year t, given by InD(t) = InD(t - 1) + K(1) I(t) = force of inflation growth during the year O() = cumulative inflation index at end of year t, given by InO(t) = InQ(t -1) + I(t) (i) Assuming dividends are paid at year end and the yield at year end is an ex- dividend yield, write down an expression for the total return on an equity from to f + 1 and an index-linked bond from / to f + 1. [2] (ii) Show that the following expression gives the equity risk premium Y (t) log + E log Y (1 + 1 ) +1 - log R(t) R(t + 1) 1 + 1 + K (1 + 1) - 1(1 + 1) U (1 ) where the equity risk premium is defined as the expectation of the log relative return on equities and irredeemable index linked gilts, conditional on state vector U(t). [2] (iii) Explain, by referring to the expression in (ii), under what conditions the model above would be consistent with an efficient market. [2]An investment market consists of the following four risky assets: Asset i Expected rate of return Market capitalisation E 5% 250,000 7% 250,000 9% 750,000 10% 50,000 In addition, investors can invest in a risk free asset with a return of 3% p.a. You may assume that the returns on the assets are uncorrelated and that the CAPM holds and in particular that investors have homogeneous expectations. (i) Determine the composition of the portfolio that a rational investor will select if they desire an expected return of 6% p.a. [3] (ii) By referring to the mathematical form of the CAPM, state four reasons why the actual returns on the portfolio in (i) will vary over successive years. [4]