Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either...
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Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either $160,000 or $400,000 with equal probabilities of 50%. The alternative risk-free investment in T-bills pays 5% per year.
| a. | If you require a risk premium of 8%, how much will you be willing to pay for the portfolio? | |
| b. | Suppose that the portfolio can be purchased for the amount you found in (a). What will be the expected rate of return on the portfolio? | |
| c. | Now suppose that you require a risk premium of 12%. What is the price that you will be willing to pay? | |
| d. | Comparing your answers to (a) and (c), what do you conclude about the relationship between the required risk premium on a portfolio and the price at which the portfolio will sell? |
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