Investments Thursday April 2 2009 Needtoknow HandIn 1

Investments, Thursday April 2, 2009 Need-to-know: • Hand-In #1 has been posted. Deadline April 17. • There are no lectures tomorrow. Scientific contents: • More on the results of Case 1 where Hue and Mario trade ’till equilibrium. The rest of Sharpe Ch. 2 • ”Nitty-gritty details” of utility maximization and trading. Sharpe Ch. 3 up to ~3. 8.

How? – Sharpe’s Case 1 Excel-file – ”Old school” i. e. whiteboard – My Case 1 By. Hand Excel-file supported w/ a note on Section 3. 7

In Equilibrium in Case 1 Hue and Marie completely diversify nonmarket risk away. (In this case, ”nonmarket risk” has a clear-cut interpretation: whether the fish go North or South. ) Market risk cannot be diversifed away. The less risk-averse Mario bears more of that. As compensation, his expected returns are higher (as we shall see).

Gains from Trade ”Ex-ante” (i. e. beforehand) trading makes both Hue and Mario better off. ”Ex-post”: Yeah, well, we don’t know exactly what happens. Sharpe says this in Section 2. 9. 3. Sounds perfectly reasonable. In Hand-In #1 you get to work on how (and how not) to quantify it.

Concepts and Quantitative Ceveats The market portfolio: The total of risky assets. In Case 1 the portfolio w/ 10 shares of MFC and 10 shares of HFC. (Some sources define portfolios via the security weights, not the #securities. ) Return: Sharpe’s ”returns” are ”gross rates”, i. e. price(time 1)/price (time 0). (Some sources use ”net rates” or ”profit and loss”. )