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Mortimer B. Atkins is hired as a financial analyst by the San Francisco branch of the investment banking firm of Dewey Cheatem, and Howe. Mort
Mortimer B. Atkins is hired as a financial analyst by the San Francisco branch of the investment banking firm of Dewey Cheatem, and Howe. Mort is tired of apartment living, and wants to buy a house in the bay area. Unfortunately, the cheapest house Mort finds to purchase in the area costs $110,000. The variance of the return from housing is high and only a small portion of it is correlated with market movements. In fact, the "nonsystematic" or "diversifiable" component of the variance of the return on housing is .05 which is explained by the high probability of earthquakes and unusual tax legislation pending in Sacramento. You are given the following information: = (i) (ii) (iii) (iv) Annual expected return on the market portfolio Variance of annual returns on the market portfolio Annual return on the riskless asset Covariance of the return between the market and housing 9% 0.04 6% 0.004 (a) Calculate the expected price of the home next year. (b) Calculate the total variance of the return from housing in the San Francisco area. How much of the total variance is diversifiable and how much of it non-diversifiable
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