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Rita's Utility of Final Wealth Is: Open Questions

1. The document contains a quiz with questions about portfolio theory, asset pricing models like CAPM, and market efficiency. 2. Questions involve calculating expected returns and variance of portfolios, determining if a portfolio is mean-variance efficient, analyzing assets in the context of CAPM, and identifying correct statements about the different forms of market efficiency. 3. The questions require applying concepts like risk and return, minimum variance portfolios, the capital market line, beta, and weak/semi-strong/strong forms of the efficient market hypothesis.

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58 views8 pages

Rita's Utility of Final Wealth Is: Open Questions

1. The document contains a quiz with questions about portfolio theory, asset pricing models like CAPM, and market efficiency. 2. Questions involve calculating expected returns and variance of portfolios, determining if a portfolio is mean-variance efficient, analyzing assets in the context of CAPM, and identifying correct statements about the different forms of market efficiency. 3. The questions require applying concepts like risk and return, minimum variance portfolios, the capital market line, beta, and weak/semi-strong/strong forms of the efficient market hypothesis.

Uploaded by

ArmanbekAlkin
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Fall 2005: FiSOOO - Ouiz #2

Part I - Open Questions


1. Rita's utility of final wealth is defined by u(w)=~w. She is broke but one lucky day she
found a lottery ticket with two possible outcomes: $196 with probability 0.25 and $100 with
probability 0.75.

1a. What is the expected utility of Rita's final wealth? (4 points)

1b. What is the lowest price that Rita will accept for her lottery ticket?

lc. My utility of final wealth is also defined by u(w)=~w, but I have $1,000 in my
pocket. What is my utility of my final wealth? (4 points)

1d. I offer to buy the lottery ticket from Rita for $122. If I buy the ticket, what is my
expected utility of final wealth? (4 points)
(Note that if I had $1,000 and paid $122 for the ticket, then my final wealth should be
(1,000- 122)+the payoff of the lottery ticket).

le. Comparing your answers to c (without the ticket) and d (with the ticket), did
buying the lottery ticket for $122 increase my welfare? (4 points)
2. The RiskAreUs family can invest only in one of the following risky assets (with
normally-distributed returns):

Expected Return - p Std of the Return - o I3

2a. Mr. RiskAreUs is risk-neutral, which investment does he prefer? - Explain (no
more than 10 words) (5 points).

2b. Mrs. RiskAreUs is risk-averse, which investment does she prefer? - Explain (no
more than 20 words) (5 points).

2c. Junior points out that something must be wrong with the data, since C ~ but
J CJB at
the same time PA<PB. IS Junior's statement correct? - Explain (no more than 20
words and two sketches. I think that a good explanation in this case should
include a sketch of assets A and B in the p-CJand p-P planes) (5 points).
m \.
2a. Mr. RiskAreUs prefers to invest in asset6 because, ... (max 10 words).
3. Suppose there are two risky assets, A and B, with the following distribution of returns
The state of the economy Probability RA RB
Recession 0.2 (-2%) (-5%)
Normal 0.5 0% 10%
Expansion 0.3 20% 15%

3a. Calculate the vector of expected returns. (4 points)

3b. Calculate the variance-covariance matrix. (4 points)

3c. Find the global minimum-variance portfolio. (4 points)

3d. Calculate the expected return and the Std of the return of the global minimum-variance
portfolio. (4 points)

3e. Calculate the expected return and the Std of the return of the portfolio p = {wA=0.7,
wB=0.3).Is this portfolio Mean-Variance efficient? (4 points)
Part I1 - Multiple Choice Questions
4. The minimum variance frontier I is located to the left and to the north of the
minimum variance fiontier I1 in the p-o plane:

Which of the following statements is correct? (9 points)


d a. The minimum variance frontier I may represents portfolios with more assets than
the portfolios on frontier II.
\f b. The minimum variance frontier I may represents portfolios of risky assets with
lower correlations than the assets in the portfolios on frontier II.
d c. The minimum variance frontier I may represents portfolios of assets constructed
without a short sales constraint, while on fiontier 11 we will find the portfolios
constructed with a short sales constraint.
0 Statements (a), (b) and (c) are correct.
e. None of the above.
5. The expected return of the market portfolio is pm=20%and the return on the risk-
free asset is rf=4%. What can you say about the composition of the efficient
portfolio (on the CML) that has an expected return of p,=36%? (9 points)
a. We need data about the risk in the market to answer this question.
b. We need data about the beta of the market portfolio to answer this
question.
0 2 0 0 % is invested in the market portfolio and (-100%) in the risk-free asset.
d. 20% is invested in the market portfolio and 80% in the risk-free asset.
e. Such a portfolio is not feasible.

6. There is one risk-free and only two risky assets in the economy with the following
parameters:
pa = 10% a, =5% pab=(-0.5)
pb = 15% a, = 10% r, = 5%
What is the proportion of asset a in the market portfolio? (9 points)

e. None of the above.


7. The expected return of the market portfolio is p,=12%, the Std of the return on
that portfolio is 0,,,=18% and the return of the risk-fiee asset is +6%. There are
two risky assets in this market with the following parameters:
!'(cfif~) &
, p - The (market) Expected Return o - The Std of the Return P
- 4u. = A
15% 22% 1.5

a~ i B 10% 20% 0.4

Assuming that the CAPM model should hold, which of the following statements
is correct? (9 points)
)j a. The market is in equilibrium (CAPM).
b. B is overpriced (by the market relative to the CAPM), since it's expected
return is lower than the expected return of the market portfolio and it's Std of
return is higher than the Std of return of the market portfolio.
X c. In equilibrium (CAPM), we expect asset A to have a lower price than its
current market price.

0 d. In equilibrium (CAPM), we expect asset B to have a higher price than its


current market price. Y ~ ( C ~ ~ P ' )=p8*Y% 102 = yBCl(QC\cc+)
e. None of the above. =Q ~ J c f i f ~ ) P & ( ~ s r h t )

,;> priw Q +8 in A JU
+\4 ~ 1 ks ~ ~t 80'4
8. Which of the following statements is correct? (9 points)
a. The weak form of market efficiency says that all information in past prices
is reflected in current prices.
b . The semi-strong form of market efficiency implies that security prices
reflect all available public information.
J c. The strong form of market efficiency is consistent with managers being
consistently able to do better than the S&P market index (a proxy for the
market portfolio) if they invest in a portfolio with a beta above 1.
d. Only statements (a) and (b) are correct.
&Statements (a), (b) and (c) are correct.

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