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QUESTION 1: Shoesmith Wave, Inc., a new and largely unproven economic forecasting service, expects the inflation rate in South Korea to average 9 percent per year over the next five years. In comparison, Shoesmith expect a U.S. government inflation rate over this time to be 3 percent per year. The yield on 5-year U.S. government bonds is 6 percent per year. The yield on 5-year Korean government bonds is 11 percent per year. One percentage point of this yield differential can be accounted for by political risk differences between the United States and South Korea, with the United States perceived as having the lower political risk. The current exchange rate is 1220 won per dollar.
REQUIRED: Forecast the future 5-year spot rate for the won (versus the dollar) using the Shoesmith Wave forecast and the forecast from the financial markets.
The expected rate of return on the market portfolio is 8.50% and the risk-free rate of return is 2.50%. The standard deviation of the market portfolio is 24%. What is the representative investor's average degree of risk aversion?
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