Week 9
1. Suppose there are three possible states of the world and that an asset (call it Asset A) has the following return profile over these three states:
|
|
State 1
|
State 2
|
State 3
|
|
Return on Asset A
|
10%
|
20%
|
0%
|
|
Probability of State
|
0.25
|
0.50
|
0.25
|
An alternate asset, asset B, has the following return profile over the three states:
|
|
State 1
|
State 2
|
State 3
|
|
Return on Asset B
|
5%
|
15%
|
15%
|
|
Probability of State
|
0.25
|
0.50
|
0.25
|
Compute the expected return on these assets and their standard deviations Comment on which of the two assets should be more valuable.
2. Suppose there are now only two possible states of the world and that an investor has two assets available to her for purchase. These assets have the following payoff profile across the two states of the world:
|
|
State 1
|
State 2
|
|
Return on Asset X
|
$20
|
$0
|
|
Return on Asset Y
|
$0
|
$10
|
|
Probability of State
|
0.60
|
0.40
|
The investor wishes to hold a fraction b (or (100*b)% of her portfolio in asset X and a fraction 1-b (or (100*(1-b))%) of her portfolio in asset Y. Find the value of b that makes this portfolio riskless for the investor. What is the expected return on this riskless portfolio?
3. If you decide to hold $100 less cash than usual and therefore deposit $100 in cash in the bank, what effect will this have on checkable deposits in the banking system if the rest of the public keeps its holdings of currency constant (use the simple deposit multiplier)?
4. List the three major monetary policy tools available for use by the Federal Reserve and the advantages and disadvantages of each tool. Which of these tools does the Fed use most often?