Jocelyn is indifferent between investing all her wealth (which is $5 million) in the risky asset and

the risk-free asset. The risky asset has an expected rate of return of 12% per year and a standard

deviation of 20% per year.

The risk-free lending rate is 6% per year. The risk-free borrowing rate is 8%. Answer the following

questions.

a) What does it mean by "Jocelyn is indifferent between investing all her wealth (which is $5

million) in the risky asset and the risk-free asset."?

(3 marks)

b) Compute Jocelyn's risk aversion coefficient. [Hint: Note the issue of "decimal and

percentage" when using the risk aversion equation.]

(3 marks)

c) What would be the optimal mix of the risky and the risk-free asset for Jocelyn given your

answer to (a)?

(3 marks)

d) Mr. Hulk, a personal friend of Jocelyn, manages an investment fund. He offers a risk-free

investment opportunity of 7% per year to Jocelyn, provided she can invest a minimum of $5

million. Suppose the investment opportunity is truly risk-free. Jocelyn realizes that in order

to take advantage of this opportunity, she has to invest all her wealth with Mr. Hulk.

Should she invest all her wealth with Mr. Hulk earning a risk-free rate of 7% instead of

holding the optimal mix you computed in part (c) above? Support your answer with

calculations. [Note: Several steps of calculation would be required to arrive at the answer.

Full mark would only be given if the calculations are shown clearly in that the meanings of

the numbers calculated are provided.]