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Question 10 (10 marks) Penny is a risk averse investor. She has a utility function of the form U = E(R) - 0.5A0 and a
Question 10 (10 marks) Penny is a risk averse investor. She has a utility function of the form U = E(R) - 0.5A0 and a risk aversion coefficient (A) of 5. The risk-free rate of return is 4%. Penny can invest in one of the following four well- diversified, risky portfolios: Standard Deviation Expected Return 11% Mild Portfolio Tangy Portfolio Spicy Portfolio 11% 10% 15% 17% 18% Volcano Portfolio 22% 18% a) If Penny can only pick one risky portfolio, which one would she prefer if she is unable to borrow or lend at the risk free rate? Why? (5 marks) b) If Penny can only pick one risky portfolio, which one would she prefer if she can lend at the risk-free rate, but cannot borrow at the risk-free rate? Why? (5 marks) Question 10 (10 marks) Penny is a risk averse investor. She has a utility function of the form U = E(R) - 0.5A0 and a risk aversion coefficient (A) of 5. The risk-free rate of return is 4%. Penny can invest in one of the following four well- diversified, risky portfolios: Standard Deviation Expected Return 11% Mild Portfolio Tangy Portfolio Spicy Portfolio 11% 10% 15% 17% 18% Volcano Portfolio 22% 18% a) If Penny can only pick one risky portfolio, which one would she prefer if she is unable to borrow or lend at the risk free rate? Why? (5 marks) b) If Penny can only pick one risky portfolio, which one would she prefer if she can lend at the risk-free rate, but cannot borrow at the risk-free rate? Why
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