Question

3. A moderately risk-averse investor has 50% of her portfolio invested in stocks and 50% in risk-free Treasury bills. Show how each of the following events will affect the investor’s budget line and the proportion of stocks in her portfolio: (i). The return on risk-free Treasury bills decreases.

Answer 1

Investor is choosing a 50% stock and 50% in treasury bill keeping in mind a expected return. When the risk free interest rate decreases to achieve the same level of return the investor will have to invest more on stocks and less in treasury bills since stock will give a higher return than the treasury bill. Hence the investor will move down along the Budget line.