Answer:
Kindly check explanation
Explanation:
Given the following :
Risk free return (risk less investment) = 5%
Cashflow derived from portfolio = $50,000 or $150,000 each at a probability of 0.5
(a) If you require a risk premium of 10%, how much will you be willing to pay for the portfolio?
Risk premium = 10%
Required return on portfolio = risk premium + risk free return = (10% + 5%) = 15%
Expected value of cashflow:
(0.5 × $50,000) + (0.5 × $150,000)
$25,000 + $75,000 = $100,000
Value of portfolio = Amount paid(a) × (1 + required return)
100,000 = a( 1 + 0.15)
100,000 = 1.15a
a = (100,000 / 1.15)
a = 86956.521
a = $86,956.5
B) If amount paid for portfolio = $86,956.5
Expected rate of return :
(Expected value - amount paid) / amount paid
= ($100,000 - $86,956.5) / $100,000
= $13043.5 / $100,000
= 0.130435 = 13.04%
C.) Now suppose you require a risk premium of 15%. What is the price you will be willing to pay now?
Risk premium = 15%
Required return on portfolio = risk premium + risk free return = (15% + 5%) = 20%
Value of portfolio = Amount paid(a) × (1 + required return)
100,000 = a( 1 + 0.20)
100,000 = 1.20a
a = (100,000 / 1.20)
a = 83333.333
a = $83,333.3
D.)
At a required risk premium of 10%, portfolio will sell at $86,956.5
At a required risk premium of 15%, portfolio will sell at $83,333.3
Hence, the price at which a portfolio will sell decreases as risk premium increases.
