Reference no: EM133041751

Question -

Part 1 - Utility in finance vs utility in economics - Indifference curve in finance is positively sloped, while indifference curve in economics1 is negatively sloped - why? Explain in detail with the figures of the curves.

Part 2 - Risk assessment for stock market investment - You decided to try your luck in stock market by investing in stocks of a single company. Your friend is an investor in stock market for several years and he has investments in large diversified portfolio. You thought it would be good idea to discuss with your friend and get some information about stock market investment. Your friend advised you to invest in stocks of XYZ Co., and said that he was also considering to include stocks of XYZ Co. in his diversified portfolio. Clearly explain how your approach/method of risk assessment/computation of the returns of XYZ stocks differs from that of your friend who was considering to include stocks of XYZ Co. in his diversified portfolio.

Part 3 - Capital market line with different lending and borrowing rates - Consider two investors: Investor-1 (henceforth Inv-1) and Investor-2 (henceforth Inv-2). Risk-free rate for Inv-1 is 5%. Return on risky portfolio is 12%. Inv-1 invests $20,000 in risk-free asset and $30,000 in the risky portfolio. Inv-2 has $40,000 and borrows additional $20,000 at 6%2 and invests the entire $60,000 in risky portfolio.

(a) For Inv-1 draw the capital market line and show the approximate point where the indifference curve of Inv-1 is tangent to the Capital Market Line (CML).

(b) Compute the expected return of Inv-1's portfolio comprising risk-free asset and risky portfolio.

(c) Draw capital allocation line for Inv-2 (equivalently draw the CML with different lending rate (5%) and borrowing rate (6%)) and show the approximate point where the indifference curve of Inv-2 is tangent to the CML.

(d) Compute the expected return of Inv-2's portfolio comprising risky portfolio only.