Reference no: EM133118281

Consider an economy with N uncorrelated risky assets and one riskless asset. The CAPM is assumed to hold. The economy has two types of investors, conservative and aggressive. Conservative investors are twice more risk averse than aggressive investors.

1. Suppose that N = 1. If conservative investors invest 70% of their wealth on the risky asset, what is the share invested in the risky asset by aggressive investors? How much do aggressive investors need to borrow to finance their position in the risky asset? Suppose now that N = 2. Conservative investors are assumed to invest 50% of their wealth in the first risky asset and 20% in the second risky asset.

2. How much do aggressive investors hold of the two risky assets?

3. Suppose that the two assets have the same variance and that the expected excess return on the second asset is 3%. What is the expected excess return on the first asset?

4. Assume the conditions of item 3 hold and that the market beta of the second asset is 0.5. What is the market beta of the first asset? What is the expected excess return on the market?