the result is con- sistent with your answer to question 13.     SOLUTIONS TO CONCEPT C H E C K S 1. The expected rate of return on the risky portfolio is $22,000/$100,000 .22, or 22%. The T-bill rate is 5%. The risk premium therefore is 22% 5% 17%. 2. The investor is taking on exchange rate risk by investing in a pound-denominated asset. If the exchange rate moves in the investors favor, the investor will benefit and will earn more from the U.K. bill than the U.S. bill. For example, if both the U.S. and U.K. interest rates are 5%, and the current exchange rate is $1.50 per pound, a $1.50 investment today can buy one pound, which can be invested in England at a certain rate of 5%, for a year-end value of 1.05 pounds. If the year-end exchange rate is $1.60 per pound, the 1.05 pounds can be exchanged for 1.05 $1.60 $1.68 for a rate of return in dollars of 1 r $1.68/$1.50 1.12, or 12%, more than is available from U.S. bills. Therefore, if the investor expects favorable exchange rate movements, the U.K. bill is a speculative investment. Otherwise, it is a gamble. II. Portfolio Theory 6. Risk and Risk Aversion The McGraw−Hill Companies, 2001           170 PART II Portfolio Theory       SOLUTIONS TO CONCEPT C H E C K S 3. For the A 4 investor the utility of the risky portfolio is U 20 (.005 4 202) 12   while the utility of bills is U 7 (.005 4 0) 7   The investor will prefer the risky portfolio to bills. (Of course, a mixture of bills and the portfolio might be even better, but that is not a choice here.) For the A 8 investor, the utility of the risky portfolio is U 20 (.005 8 202) 4   while the utility of bills is again 7. The more risk-averse investor therefore prefers the risk-free alternative. 4. The less risk-averse investor has a shallower indifference curve. An increase in risk requires less increase in expected return to restore utility to the original level.     E(r)