Suppose a risk neutral agent has $100,000 today that he wants to save for one year. Compare the following two savings plans.

Bank A offers a standard savings account with 4% p.a.

Bank B offers the following alternative:

There is a basis interest rate of 1% p.a. and 50% participation on the performance of the S&P500. The maximum interest rate is capped at 7% p.a. (E.g. If the S&P increases by 6%, there is a bonus of 3% so that the total return is 4% p.a. If the return of the S&P is 20%, the plan has a return of 7%. Note, if the S&P has a negative return, the interest rate remains at 1% p.a.)

Suppose the S&P has 1000 points at t=0. At t=1 it can have {900, 990, 1000, 1020, 1040, 1100, 1120, 1200, 1260, 1300} points with equal probability.

(a) Draw the payoff of alternative B as a function of the S&P (with the S&P performance on the X-axis, and the return of the plan on the Y-axis.)

(a) The agent maximizes the expected amount at t=1. Which plan is better? How much more can the agent spend in expectation at t=1, if he chooses the better one?

 

Posted Date: 3/29/2013 5:30:18 AM | Location : United States

Ask an Expert

Related Discussions:- Basic interest rate and maximum interest rate, Assignment Help, Ask Question on Basic interest rate and maximum interest rate, Get Answer, Expert's Help, Basic interest rate and maximum interest rate Discussions

Write discussion on Basic interest rate and maximum interest rate
Your posts are moderated

Write your message here..

Related Questions

T-account, Received 10,000 contribution from bill london in exchange for co... Received 10,000 contribution from bill london in exchange for common stock What 2 accounts are used

Recording and reporting Equity, Ask qCamp Corp had the following balances i... Ask qCamp Corp had the following balances in its stockholders'''' equity at jan 1: Common stock, $2, par value, 450,000 shares issued $900,000 Additional pd in capial 1,200,000 Ret

Estimate expected returns, Use the data from "Beating the Market Quarterly"... Use the data from "Beating the Market Quarterly" problem. Use that data to estimate expected returns and a covariance table for the 5 stocks from that problem. Use your estimates t

Absorption costing, Absorption costing is a cost accounting method that ... Absorption costing is a cost accounting method that tries to charge all direct costs and all production costs of an organization to specific units of pr

Inventory, Can I send you my homework? Can I send you my homework?

#title.Current Issue in financial Accounting, 2 Individual Research Assignm... 2 Individual Research Assignment This assignment is an individual assessment. The research and written submission should therefore be your own work. You will need to submit this as

Accounting for investment, Case laws related to accounting for investment Case laws related to accounting for investment

Classifying expenses by nature-income statement, Classifying expenses by na... Classifying expenses by nature Under this format, expenses are not classified by their nature i.e. referred to specifically according to their type and the major categories of ex

What is reconnaisance survey, Q. What is Reconnaisance Survey explain? ... Q. What is Reconnaisance Survey explain? This item should apply to all rough and rapid investigations of an area with a view to determine the technical feasibility and approxim

Illustration of head office records-branches, Illustration of Head office r... Illustration of Head office records In order to provide a check that branch managers and staff deal properly with goods and cash passing through their hands, goods are normally