The price of risk measures how risk and return can be traded off in making portfolio...

The price of risk measures how risk and return can be traded off in making portfolio choices. Assume that the standard deviation of a risky asset is 2.00% (and does not change) with a return of 8.00%. You also have the choice to invest in a risk-free asset with return 4.00%.

If the risk-free return increases by 1.00 percentage points and the risky asset return increases by 7.00 percentage points, what is the change in the price of risk (in percentage points)? (Round to two decimals, if necessary.)

HINT: Recall that the price of risk is the difference in returns from a risky asset compared to a risk-free asset relative to the standard deviation of the risky asset.

Expert Solution

Market price of Risk = Expected return - Risk free return/ Standard deviation

Originally market price of risk was = (8-4)/2 = 2 units

Now in new market conditions we have

Market Price of Risk = (15-3)/2 = 7.5 units

hence % change in price of risk = (7.5-2)/2 = 275 percentage points

Rahul Sunny answered 2 years ago

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