*please explain how to do* Consider a risky portfolio. The end-of-year cash flow

Question

*please explain how to do*

Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either $40,000 or $135,000, with equal probabilities of 0.5. The alternative riskless investment in T-bills pays 4%.

If you require a risk premium of 10%, how much will you be willing to pay for the portfolio? (Round your answer to the nearest dollar amount.)

Suppose the portfolio can be purchased for the amount you found in (a). What will the expected rate of return on the portfolio be? (Do not round intermediate calculations. Round your answer to the nearest whole percent.)

Now suppose you require a risk premium of 15%. What is the price you will be willing to pay now?(Round your answer to the nearest dollar amount.)

*please explain how to do*

Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either $40,000 or $135,000, with equal probabilities of 0.5. The alternative riskless investment in T-bills pays 4%.

Explanation / Answer

a. risk premium = required return - risk free rate

required return = 10%+4% = 14%

Expected value of the payoff = 40000*1/2 + 135000*1/2 =$87500

Value of portfolio = 87500/(1+14%) = $76,754

b. the expected rate of return on the portfolio = (87500-76,754.39)/76,754.39 = 14%

c.risk premium = required return - risk free rate

required return = 15%+4% = 19%

Expected value of the payoff = 40000*1/2 + 135000*1/2 =$87500

Value of portfolio = 87500/(1+19%) = $73529

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