a) Discuss the difference between a price-weighted index and a value-weighted index.Give one example for the price-weighted index and one example for the value-weightedindex and discuss any problems/advantages associated with the specific indices.b) We assume that investors use mean-variance utility: U = E(r) – 0.5 × Ao², whereE(r) is the expected return, A is the risk aversion coefficient and o? is the varianceof returns. Given that the optimal proportion of the risky asset in the complete port-folio is given by the equation y* = E , where r; is the risk-free rate, E(rp) isthe expected returm of the risky portfolio, o, is variance of returns, and A is the riskaversion coefficient. For each of the variables on the right side of the equation, discussthe impact of the variable's effect on y* and why the nature of the relationship makessense intuitively. Assume the investor is risk averse.Ao

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Corporate Fin Focused Approach

5th Edition

ISBN:9781285660516

Author:EHRHARDT

Publisher:EHRHARDT

Chapter6: Risk And Return

Section: Chapter Questions

Problem 1Q

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Mean-variance expected utility is given by Eu = e-, where e is expected return, v is the variance of the portfolio and tis risk tolerance. Suppose an investor has risk-loving preferences. What can we say about the value of t? Select one: Ot1 O. t>0 O t=0
Suppose the utility function is U = E(r) - 0.5Ao2. Draw the indifference curve corresponding to a utility level of 0.2 for an investor with a risk aversion coefficient of 3. Please note the vertical line indicates expected return, and plot standard deviation on the horizontal line.
Consider the following linear regression model: (R₁-r)= a; + b(RMkt - rf) + e; The b; in the regression: O measures the deviation from the best fitting line and is zero on aver- measures the sensitivity of the security to market risk. measures the diversifiable risk in returns.
a)define market risk. b)define delta-hedged position and describe delta hedging. c)describe gamma hedging and vega hedging. d)define and explain value at risk (VAR). e)describe the analytical (variance-covariance) method of calculating VAR, and discuss its advantages and disadvantages.
Suppose you have mean-variance utility function with a coefficient of risk Aversion-0, which stocks are preferred to P. E(r) III IP II IV Standard Deviation
On the basis of the utility formula below, which investment would you select if you were risk averse with A = 4? Investment Expected return E(r) Standard deviation σ 1 0.12 0.30 2 0.15 0.50 3 0.21 0.16 4 0.24 0.21
Consider the following regression Pt * - Pt = .07(1.4) + .4*Pt (3.6) + et where Pt * is Shiller’s ex post price of a stock, Pt is the actual price and t-ratios are in brackets. Explain in words and analytically what the dependent variable Pt * - Pt should be equal to under the efficient markets theory. Hence interpret the regression. Does it support the efficient markets theory?
The expected rate of return of an investment ________. a. equals one of the possible rates of return for that investment b. equals the required rate of return for the investment c. is the mean value of the probability distribution of possible returns d. is the median value of the probability distribution of possible returns e. is the mode value of the probability distribution of possible returns
Which one of the following statements is correct? Multiple Choice The risk-free rate of return has a risk premium of 1.0. The reward for bearing risk is called the standard deviation. Risks and expected return are inversely related. The higher the expected rate of return, the wider the distribution of returns. Risk premiums are inversely related to the standard deviation of returns.
What must be true about the sign of the risk aversion coefficient, A, for a risk lover? Draw the indifference curve for a utility level of .05 for a risk lover.
An ideal value-relevant attribute is one for which the correlation coefficient of the values of the attribute and the stock prices is Group of answer choices a. +2.0 b. zero c. +1.0 d. -1.0
In the context of the Capital Asset Pricing Model (CAPM), the relevant measure of risk is A. standard deviation of returns. B. beta. C. variance of returns. D. unique risk.

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Discuss the difference between a price-weighted index and a value-weighted index. Give one example for the price-weighted index and one example for the value-weighted index and discuss any problems/advantages associated with the specific indices.