Download Problems Set 7 Solutions - Investment, Capital, and Finance | ECON 422 and more Assignments Economics in PDF only on Docsity! Econ 422 E. Zivot Summer 2008 Problem Set 7 Solutions BM Chapter 8 Quiz Questions 8.7, 8.8 See solutions in the back of the textbook. BM Chapter 8 Practice Questions 8.14, 8.22 8.14. In the context of a well-diversified portfolio, the only risk characteristic of a single security that matters is the security’s contribution to the overall portfolio risk. This contribution is measured by beta. Lonesome Gulch is the safer investment for a diversified investor because its beta (+0.10) is lower than the beta of Amalgamated Copper (+0.66). For a diversified investor, the standard deviations are irrelevant. 8.22. a. In general, we expect a stock’s price to change by an amount equal to (beta × change in the market). Beta equal to –0.25 implies that, if the market rises by an extra 5%, the expected change in the stock’s rate of return is –1.25%. If the market declines an extra 5%, then the expected change is +1.25%. b. “Safest” implies lowest risk. Assuming the well-diversified portfolio is invested in typical securities, the portfolio beta is approximately one. The largest reduction in beta is achieved by investing the $20,000 in a stock with a negative beta. Answer (iii) is correct. BM Chapter 9 Quiz Questions 9.1, 9.2, 9.3, 9.4, 9.6 See solutions in the back of the textbook. BM Chapter 9 Practice Questions 9.8, 9.10, 9.11, 9.15, 9.18 9.8. a. False – investors demand higher expected rates of return on stocks with more nondiversifiable risk. b. False – a security with a beta of zero will offer the risk-free rate of return. c. False – the beta will be: (1/3 × 0) + (2/3 × 1) = 0.67 d. True. e. True. 9.10. a. Portfolio r σ 1 10.0% 5.1% 2 9.0 4.6 3 11.0 6.4 b. See the figure below. The set of portfolios is represented by the curved line. The five points are the three portfolios from Part (a) plus the following two portfolios: one consists of 100% invested in X and the other consists of 100% invested in Y. c. See the figure below. The best opportunities lie along the straight line. From the diagram, the optimal portfolio of risky assets is portfolio 1, and so Mr. Harrywitz should invest 50 percent in X and 50 percent in Y.
