What are the relationship between y1 and y2, U1 and U2:

Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Eugene F. Brigham, Phillip R. Daves
Chapter3: Risk And Return: Part Ii
Section: Chapter Questions
Problem 7MC: Write out the equation for the Capital Market Line (CML), and draw it on the graph. Interpret the...
icon
Related questions
Question
Assuming two risk-free rates for lending and borrowing in the market: r(f) and r(b). Suppose your utility
function is described by U = E(r) - 0.5A xo² with A> 0, and you are combining the risk-free asset
with the optimal risky asset to maximize the utility. Consider the following two situations:
1. Suppose r(b) = r(f): you form the optimal complete portfolio C1 by borrowing money at r(f) and invest y1
(i.e., y1 represents portfolio weight) in the optimal risky portfolio (P1). Your utility score under this situation
is denoted as U1;
II. Suppose r(b) >r(f): you form another optimal complete portfolio C2 by borrowing money at r(b) and invest
y2 (1.e., y2 represents portfolio weight) in the optimal risky portfolio (P2). Your utility score under this
situation is denoted as U2.
For simplicity, let's assume the optimal risky portfolios under these two situations are the same (i.e.,
E(P1)=E(P2) and o(P1) = o(P2)).
What are the relationship between y1 and y2, U1 and U2:
O a. y1=y2 and U1=U2
O b. No enough information to tell
Oc. y1>y2 and U1<U2
O d. y1<y2 and U1<U2
Oe. y1>y2 and U1>U2
4
Transcribed Image Text:Assuming two risk-free rates for lending and borrowing in the market: r(f) and r(b). Suppose your utility function is described by U = E(r) - 0.5A xo² with A> 0, and you are combining the risk-free asset with the optimal risky asset to maximize the utility. Consider the following two situations: 1. Suppose r(b) = r(f): you form the optimal complete portfolio C1 by borrowing money at r(f) and invest y1 (i.e., y1 represents portfolio weight) in the optimal risky portfolio (P1). Your utility score under this situation is denoted as U1; II. Suppose r(b) >r(f): you form another optimal complete portfolio C2 by borrowing money at r(b) and invest y2 (1.e., y2 represents portfolio weight) in the optimal risky portfolio (P2). Your utility score under this situation is denoted as U2. For simplicity, let's assume the optimal risky portfolios under these two situations are the same (i.e., E(P1)=E(P2) and o(P1) = o(P2)). What are the relationship between y1 and y2, U1 and U2: O a. y1=y2 and U1=U2 O b. No enough information to tell Oc. y1>y2 and U1<U2 O d. y1<y2 and U1<U2 Oe. y1>y2 and U1>U2 4
Expert Solution
steps

Step by step

Solved in 3 steps with 1 images

Blurred answer
Knowledge Booster
Techniques of Time Value Of Money
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.
Similar questions
  • SEE MORE QUESTIONS
Recommended textbooks for you
Intermediate Financial Management (MindTap Course…
Intermediate Financial Management (MindTap Course…
Finance
ISBN:
9781337395083
Author:
Eugene F. Brigham, Phillip R. Daves
Publisher:
Cengage Learning