1. Next year a security will yield 98 with a probability of 0.65 and 112 with a probability of 0.35. An investor is willing to pay 90 for this asset today. The risk-free interest rate is 10%. Answer the following questions (show all the details of your calculations):

1. Is this investor risk seeking or risk averse? Explain.

2. What is the risk premium?

3. Assume that the investor is ready to pay 88 for this asset, is this investor risk seeking or risk averse? Explain.

4. Considering the result in question (iii) above, what is the risk premium?

Heading 1 List Paragraph Normal No b) Next year a security will yield 98 with a probability of 0.65 and 112 with a probability of 0.35. An investor is willing to pay 90 for this asset today. The risk-free interest rate is 10%. Answer the following questions (show all the details of your calculations): i) Is this investor risk seeking or risk averse? Explain. 1,10 marks) ii) What is the risk premium? (5 marks) iii) Assume that the investor is ready to pay 88 for this asset, is this investor risk seeking or risk averse? Explain. (10 marks) iv) Considering the result in question (iii) above, what is the risk premium? (5 marks) [TOTAL: 50 MARKS] BE313-5-AU/3 QUESTION TWO a) Suppose that a well-diversified portfolio has an expected return of 23% and that the following two factors have an impact on this portfolio's returns: changes to GDP (Fi), and to unexpected inflation (F2). The risk-free rate is 5%. The APT equation is E(R) - Ry+B(A - Rp) + Ba(F2 - Rj) = 0.05 + B.00.085) + B2(0.135) 1) Suppose that the sensitivity of the well-diversified portfolio to GDP is (-0.85). What is its sensitivity to unexpected inflation? (10 marks) If one rebalances this well-diversified portfolio, such that the expected return remains the same but the exposure to inflation is reduced to zero, what will its sensitivity to GDP be