Now suppose there is no financial intermediary to handle liquidity shocks. However, at t = 1 a market for bonds opens up and agents can trade their wealth at t = 1 for wealth at t = 2. Each bond pays 1 at t = 2 and its price is pM. Calculate the consumer's optimal investment decision IM at t = 0, the price of the bond p¹, and the optimal consumption in the two states M, CM. Compare the mutual fund and bond market allocations: are CM and CM bigger or smaller than c and c respectively?

Now suppose there is no financial intermediary to handle liquidity shocks. However, at t = 1 a market for bonds opens up and agents can trade their wealth at t = 1 for wealth at t = 2. Each bond pays 1 at t = 2 and its price is pM. Calculate the consumer's optimal investment decision IM at t = 0, the price of the bond p¹, and the optimal consumption in the two states M, CM. Compare the mutual fund and bond market allocations: are CM and CM bigger or smaller than c and c respectively?

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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The market portfolio (M) has the expected rate of return E(rM) = 0.12. Security A is traded in the market. We know that E(rA) = 0.17 and βA = 1.5. (1) What is the rate of return of the risk-free asset (rf)? (2) Security B is also traded in the market. βB = 0.8. Then what is “fair” expected rate of return of security B according to the CAPM? (3) Security C is a third security traded in the market. βC = 0.6, and from the market price, investors calculate E(rC) = 0.1. Is C overpriced or underpriced? What is αC?
Assume that security returns are generated by the single-index model,Ri = αi + βiRM + eiwhere Ri is the excess return for security i and RM is the market’s excess return. The risk-free rate is 2%. Suppose also that there are three securities A, B, and C, characterized by the following data: Security βi E(Ri) σ(ei) A 0.7 7 % 20 % B 0.9 9 6 C 1.1 11 15 a. If σM = 16%, calculate the variance of returns of securities A, B, and C. b. Now assume that there are an infinite number of assets with return characteristics identical to those of A, B, and C, respectively. What will be the mean and variance of excess returns for securities A, B, and C? (Enter the variance answers as a percent squared and mean as a percentage. Do not round intermediate calculations. Round your answers to the nearest whole number.)
Assume that security returns are generated by the single-index model, Ri = αi + βiRM + ei where Ri is the excess return for security i and RM is the market’s excess return. The risk-free rate is 3%. Suppose also that there are three securities A, B, and C, characterized by the following data: Security βi E(Ri) σ(ei) A 1.4 14 % 23 % B 1.6 16 14 C 1.8 18 17 a. If σM = 22%, calculate the variance of returns of securities A, B, and C. b. Now assume that there are an infinite number of assets with return characteristics identical to those of A, B, and C, respectively. What will be the mean and variance of excess returns for securities A, B, and C? (Enter the variance answers as a percent squared and mean as a percentage. Do not round intermediate calculations. Round your answers to the nearest whole number.)
A security has an expected rate of return of 0.11 and has a beta (B) of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09. Show whether this security is underpriced, fairly priced or overpriced. 1. The returns on share A follow the market model with coefficients aa = 0.01, Ba = 1.25. If at time t, K MT = 0.02 and the actual return on share A is 0.025, calculate EAt (the error term). 2. 3. An investor invests 30 percent of his wealth in a risky asset with an expected rate of return of 0.15 and a variance of 0.04 and 70 percent in a risk-free asset with a return of 0.06. Calculate the portfolio's expected return. 4. Toyota stock has the following probability distribution of expected prices one year from now: State Probability Price 1 25% 40% £50 2 £60 3 35% £70 Currently, each share is priced at £55. Toyota will pay a dividend of £4 per share at the end of the year. What is your expected holding-period return on Toyota? 5. According to the Capital Asset…
Exploring Finance: Security Market Line. Security Market Line Conceptual Overview: Explore the determinants of the security market line. The Security Market Line defines the required rate of return for a security to be worth buying or holding. The line, depicted in blue in the graph, is the sum of the risk-free return (rf in the slider) and a risk premium determined by the market-risk premium (RPM) multiplied by the security's beta coefficient for risk. Drag the rf slider below the graph to change the amount of the risk-free return. These changes reflect changes in inflation. Drag the RPM slider below the graph to change the relationship between a security's beta coefficient and the amount of the market risk premium. Drag left or right on the graph to move the cursor line to evaluate securities with different beta coefficients. r = r_{RF} + RP_M * beta = 6\% + 5\% * 1 = 6\% + 5.00\% = 11.00\%r=rRF+RPM∗beta=6%+5%∗1=6%+5.00%=11.00% 1. For a risk-free return rate of 5%, a…
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Suppose you observe the following situation: Security Beta Expected Return Peat Company 1.70 13.60 Re - Peat Company 0.85 10.80 Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? What is the risk - free rate?
Suppose that x is the continuously compounded yield to maturity on a zero-coupon bond that pays off $1 at time T. Assume that x follows the process: dx = a (x₁ - x) dt + sx dz where a, x0, and s are positive constants and dz is a Wiener process. What is the process followed by the bond price? Solutions:
An efficient capital market is best defined as a market in which security prices reflect which one of the following? Multiple Choice A Current inflation B A risk premium C All available information D The historical arithmetic rate of return E The historical geometric rate of return

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