Reference no: EM132681718

Jocelyn is indifferent between investing all her wealth (which is $5 million) in the risky asset and the risk-free asset. The risky asset has an expected rate of return of 12% per year and a standard deviation of 20% per year. The risk-free lending rate is 6% per year. The risk-free borrowing rate is 8%.

b) Compute Jocelyn's risk aversion coefficient. [Hint: Note the issue of "decimal and percentage" when using the risk aversion equation.]

c) What would be the optimal mix of the risky and the risk-free asset for Jocelyn given your answer to (a)?

d) Mr. Hulk, a personal friend of Jocelyn, manages an investment fund. He offers a risk-free investment opportunity of 7% per year to Jocelyn, provided she can invest a minimum of $5 million. Suppose the investment opportunity is truly risk-free. Jocelyn realizes that in order to take advantage of this opportunity, she has to invest all her wealth with Mr. Hulk.

Should she invest all her wealth with Mr. Hulk earning a risk-free rate of 7% instead of holding the optimal mix you computed in part (c) above? Support your answer with calculations. [Note: Several steps of calculation would be required to arrive at the answer. Full mark would only be given if the calculations are shown clearly in that the meanings of the numbers calculated are provided.]