Adverse Selection Essay

588 words - 3 pages

Essay Assignment 2

Chapter 5
2. Why is it important to be able to quantify risk?
It is important to be able to quantify risk, because we want to know which investment is riskier. The riskier investment will be less desirable than others and to determine the price we are willing to price.
8. Banks pay substantial amount to monitor the risks that they take. One of the primary concerns of a banks “risk managers” is to compare the value at risk. Why is value at risk so important for the bank ( or any financial institution)?
Value at risk is the worst possible loss over a specific time horizon, at a given probability. Since the banks has a restriction of sorts the can hold, bank managers and financial regulators try to limit the chances of a financial ...view middle of the document...

So Investment C would be most attractive to a risk-averse because it has the same expected return as Investment B but is has more uncertainty with a standard deviation of 20. A risk-averse investor trades off between risk and expected return, the higher the risk, the higher the expected return risk-averse investor will require for holding an investment. My answer would change if the investor was a risk-neutral. An risk-neutral investor is totally opposite from a risk-averse investor.
Chapter 6
1. Consider a U.S. Treasury bill with 270 days to maturity. If the annual yield is 3.8 percent, what is the price?
100/ (1+0.038)^9/12= 97.24
9. You are sitting at the dinner table and you father is extolling the benefits of investing in bonds. He insists that as a conservative investor he will only make investments that are safe, and what could be safer than a bond, especially a US Treasury bond? What accounts for his view of bonds, and explain why you think it is right or wrong?
He views that the US Treasury bond are a straightforward type of bond. A Treasury bond bill represents a promise be the US government to pay $100 on a fixed future date. They are known as zero- coupon bonds, because there are no coupon payments. His thinking is right, for someone who wants a safe investment that is not looking for a big return. The interest rates are very low on treasury bills.
11. If, after one year, the yield to maturity on a multi-year coupon bond that was issued at par is higher than the coupon rate, what happened to the price of the bond during that first year?
During the first year the economy was doing well and the price of a coupon bond was able to be higher, because people were able to afford higher prices on bonds.

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