Risk averse investors require a positive risk premium to compen- sate for risks they take while risk neutral investors donit. Consider a risky portfolio. The end-of-year cash aow derived from the portfolio will be either $42,000 with probability 0.6 or $140,000 with probability 0.4. Your friend is risk neutral. She is willing to pay $80,000 for this risky portfolio today.

1. (a) What is the risk free rate implied? Show your work.

2. (b) You are risk averse, you require a risk premium of 2.5% to invest in this portfolio. How much are you willing to pay for this portfolio? Show your work.

3. (c) Another friend is more risk averse than you. If she were to consider the same portfolio, is she willing to pay more or less than you? Explain.