1) B
2) B
3) D
4) D
5) C
6) A
7) D
8) B
9) C
10) E
11) E
12) B
13) D
14) A
15) E
16) B
Question 1
a.
n
ER X probi*ri
i1
ER A 0.4(0.14) + 0.6(0.07) = 0.098
ER B 0.4(0.05) + 0.6(0.1) = 0.08
n
(proi)ir xER )
X i1
A 0.4(0.14 -0.098) + 0.6(0.07 -0.098) 0.0342929
0.4(0.05 -0.08) + 0.6(0.1 -0.08 0.0244949
B
b.
n
prob (r ER )(r ER )
XY i X ,i X Y ,i Y
i1
AB = 0.4(0.14 - 0.098)(0.05 - 0.08) + 0.6(0.07 - 0.098)(0.1 - 0.08) = -0.00084
AB 0.00084 1
AB 0.0342929*0.0244949
A B
c.
Since AB 1 , we can construct a risk-free portfolio by investing
w B 0.0244949 0.416667in Asset A, 0.583333 in Asset B.
A A B 0.0342929 0.0244949 Risk-free rate 0.416667 (0.098) 0.583663(0.08) 0.0875
d.
0.098 0.0875 A0.095 0.0875) 1A4
0.08 0.0875 B0.095 0.0875) B1
Question 2
Monthly payment for the 25-year $200,000 mortgage:
6
Monthly interest rate =1 0.18 1 0.014467
2
200,000 X *PVAF 0.014467, 300 2,932.76
Loan balance at the end of year 5: 2,936.76*PVAF 0.014467, 240,272.06
1
0.24 6
Monthly interest rate from year 6 to year 71 1 0.019068
2
Loan balance at the end of year 7 (assume no payments in years 6 and 7):
24
196,272.06* 1 0.019068 308,837.88
Value of years 6’s and 7’s payments (1,466.38 per month) at the end of year 7:
24
1,466.38*PVAF 0.019068, 240.019068) 44,106.04
Loan balance at the end of year 7: 308,837.88 – 44,106.04 = 264,731.

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