Question
You scheduled a meeting with your financial advisor Mr. Smart. The time comes, and you sit down with him at his desk and start a
You scheduled a meeting with your financial advisor Mr. Smart. The time comes, and you sit down with him at his desk and start a conversation. He makes the following statements:
1. Dear client, right now in your portfolio, you have 50% in stocks and 50% in bonds, with expected returns of 10% and 6% respectively.
2. Your stocks have a volatility of 20% and your bonds 5%, there is 0 correlation between stocks and bonds.
3. Since you are young, I think you should take more risk by changing your portfolio allocation to 60% in stocks and 40% in bonds.
4. I also want to bring your attention to a new hedge fund that is currently very popular for your level of net worth. The fund has an alpha of 5% (intercept above risk-free rate) and CAPM beta of 1.2. With the currently expected market risk premium at 5% and the risk-free rate at 2%, I think you are going to do great with this fund.
5. Finally, I would like to provide you with an opportunity to invest in an annuity product that is going to pay off for your further studies in graduate school. I heard that you are going to enroll in an Ivy League school studying modern art. The tuition is high at $80000 per year for two years. And the first payment comes in exactly one year. This annuity product has an assumed CAPM beta of 1, and alpha of 0. We are selling this product to you today at $155000. Don't miss this good deal!
Question: What's the real value of the annuity product now? Should you accept or reject the offer? Show your equation.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started