By J. Fred Weston, Kuldeep Shastri Thomas E. Copeland
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00 3. (a) The payoff table is: Nova Nutrients = j Galactic Steel = k S1 = Peace St. 6 St. 4 S2 = War St. 6 St. 36 To find the price of pure securities, P1 and P2, solve two equations with two unknowns: 6P1 + 6P2 = St. 10 4P1 + 36P2 = St. 20 34 Copeland/Shastri/Weston • Financial Theory and Corporate Policy, Fourth Edition Multiplying the first equation by six, and subtracting it from the second equation, 4P1 + 36P2 = St. 20 −[36P1 + 36P2 = St. 60] −32P1 = − 40 P1 = St. 4167 (b) Let nj = number of Nova Nutrients shares and nk = number of Galactic Steel shares.
As long as the ex-ante market rate of return is greater than the risk-free rate, the slope of the capital market line must be positive at the y-axis. Therefore, a tangency between a risk-averter’s indifference curve and the CML at the y-axis is impossible. No risk averter will hold all of his wealth in the risk-free asset. 7 No risk-averse investor will hold 100% of his wealth in the risk-free asset 13. First compute the expected returns and standard deviations for asset X. 0 VAR(X) = 430 Using the probability properties, we can immediately write the expected value and variance of asset Y.
2 Because Σ (F − G) is not always the same sign for every return, there is no second order stochastic dominance in this case. 44 squared The cumulative probability distributions cross, and there is no first order dominance. 27 28 Copeland/Shastri/Weston • Financial Theory and Corporate Policy, Fourth Edition (c) False. A risk neutral investor has a linear utility function; hence he will always choose the set of returns which has the highest mean. (d) True. Utility functions which have positive marginal utility and risk aversion are concave.