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Week 9
1. Suppose there are three possible states of the world and that an asset (call it Asset A) has the following return profile over these three states:
State 1
State 2
State 3
Return on Asset A
10%
20%
0%
Probability of State
0.25
0.50
An alternate asset, asset B, has the following return profile over the three states:
Return on Asset B
5%
15%
Compute the expected return on these assets and their standard deviations Comment on which of the two assets should be more valuable.
2. Suppose there are now only two possible states of the world and that an investor has two assets available to her for purchase. These assets have the following payoff profile across the two states of the world:
Return on Asset X
$20
$0
Return on Asset Y
$10
0.60
0.40
The investor wishes to hold a fraction b (or (100*b)% of her portfolio in asset X and a fraction 1-b (or (100*(1-b))%) of her portfolio in asset Y. Find the value of b that makes this porfolio riskless for the investor. What is the expected return on this riskless portfolio?
With respect to three goods - ice cream, green tea, and digital cameras
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