1. Let's say you face the following two gambles:
Gamble 1: .50 x ($10,000) + .50 x ($20,000)
Gamble 2: .60 x ($ 8,000) + .40 x($40,000)
If both gambles offer you the same expected utility (i.e., the same expected satisfaction), what is the dollar amount of your risk premium?
2. Explain why a common stock should be evaluated in a portfolio context as opposed to being evaluated in isolation.
3. Assume you have a two-stock portfolio. How does the correlation coefficient, ρ, between the two stocks' returns impact the standard deviation of this portfolio? Explain your answer. (Hint: The two variables under discussion are ρ and σP.)
4. When would the coefficient of variation be preferred over the standard deviation for comparing two risky stocks in isolation? Fully explain your answer.
5. Common stock mutual fund manager, Mr. Jim, forms expectations about the cyclical phase of the stock market when actively managing his fund portfolio. In what situation might Mr. Jim want to lower the average beta of the fund that he manages? Explain Mr. Jim's reasoning. (Note that a mutual fund portfolio is simply a portfolio of various stocks.)
6. What does the capital asset pricing model (CAPM) claim it can do for the investor? (Hint: The answer is not related to the "basic proposition.")