2. Bob's wealth is $2500. However, he faces a 50% chance of suffering a $900 loss. He is an expected utility maximizer and his utility function is U(w) = Vw , Where w is his wealth. (a) What is Bob's cost of risk? (b) If Bob can buy insurance against his loss for a price of $500, will he buy it? (c) What is the maximum amount Bob would be willing to pay for insurance?

16. The market consists of only two assets, A and B, with normally distributed re- turns. Asset A's returns have a mean of 18% and a standard deviation of 14% and Asset B's returns have a mean of 15% and a standard deviation of 18%. In such a scenario a risk-averse investor would always want to invest all of her money in Asset A.   17. A call option offers the purchaser limited downside loss as given by the option premium paid, combined with limited upside potential.   18. The return earned on a risk free portfolio must be equal to the risk free interest rate.   19. CAPM assumes that all investors' optimal portfolio has a fraction invested in the risk-free asset and the remaining in the minimum variance portfolio.   20. For any frontier portfolio p, except the minimum variance portfolio, there exists a unique frontier portfolio with which p has zero covariance.   21. The market portfolio of all available assets is the supply of risky assets.   22. An arbitrage opportunity is an…

3. The risk free rate is 3%. The optimal risky portfolio has an expected return of 9% and standard deviation of 20%. Answer the following questions.  (a)  Assume the utility function of an investor is U = E(r) − 0.5Aσ2. What is condition of A to make the investors prefer the optimal risky portfolio than the risk free asset? (b)  Assume the utility function of an investor is U = E(r) − 2.5σ2. What is the expected return and standard deviation of the investor’s optimal complete portfolio?

A risk-averse consumer with $100,000 in wealth faces 0.1 probability of losing half of his wealth within the next year. a. What is the consumer's expected wealth one year from now? b. An insurance company offers our consumer full insurance against the possible loss. What premium must the consumer be charged for the insurance company to expect to break even?   c. Suppose our risk-averse consumer is indifferent between getting $85,000 wealth with certainty and facing the above described uncertain situation. What is the maximum premium that the insurance company will be able to charge this consumer for its full insurance policy?